This paper examines how optimal renewable energy (RE) suppo rt policies need to be adjusted to account for carbon prices. We show theoretically and empirically that changing carbon prices requires adjusting RE production subsidiesdue to two different motives: First, RE premiums need to be reduced to reflect the carbon value embedded in the market price. Second, RE premiums and feed-in tariffs need to be adjusted once a fuel switch away from coal towards gas power occurs. This adjustment is necessary to account for changes in the marginal external benefit of RE. For the case of the UK, we use empirical estimations and numerical simulation models to quantify these effects. We show that the second effect is empirically rather small, whereas the first effect requires to completely phase-out RE premiums with increasing carbon prices due to the reflection of the carbon cost in the electricity market price. Finally, a fuel switch increases solar-induced abatement, whereas wind-induced abatement is rather invariant to a fuel switch. Yet, the differentiation of RE subsidies between wind and solar power is modest.
Abrell, Jan and Mirjam Kosch (forthcoming), The impact of carbon prices on renewable energy support, Journal of the Association of Environmental and Resource Economists.