Effective combination of emissions trading and simultaneous promotion of renewable energy

Mitigating anthropogenic climate change, the EU has established an aim of long-term reduction of greenhouse gas emissions by an average of 80 - 95% until 2050. For that purpose a trading scheme of emission rights (ETS) has been introduced, including a gradual shortage of tradable permits. The expansion of renewable energies, subsidized by various European nations in different ways, is also an objective of the EU. While both instruments aimed at the reduction of CO₂, they are very different in terms of their current and future marginal abatement costs (MAC). The ETS aimed at increasing efficiency within the fossil fuel sector due to their currently comparatively lower MAC (efficiency strategy), whereas the promotion of renewables leads to replacement of fossil capacity (substitution strategy).

Environmental economics usually assumes MAC increasing with additional mitigation efforts. Due to physical limitations this effect is more pronounced in the efficiency than in the substitution strategy, what makes MAC parity of these strategies occur at a certain emission level. Hence the ETS brings renewables even without their promotion to market, while the efficiency strategy will be omitted in the subsequent period due to their now higher MAC. The resulting sequence of the two strategies reveals in particular the disadvantage of the lower realization of learning effects, because both strategies are limited to a shorter period. On the other hand, to avoid inefficiencies in their simultaneous application, only that share of emissions should be avoided by renewables, which builds the most cost-effective mitigation strategy. For this, knowledge of the emission level of MAC parity is required, which may be referred to as turning point of mitigation strategies.

From standard microeconomic analysis, we determine whether the emission level of the turning point is reached at a given state of expansion of renewables, such that their further promotion would lead to inefficiencies. This model-theoretic considerations prove to be robust to a change of pattern of MAC, while resulting variances can be narrowed down and quantified. The advantage is the direct application to empirical data without knowledge of exact future progress of MAC. As an example we develop assessment indicators for the success of renewables and the ETS and evaluate Germany´s electricity sector with our tool. Beyond pure analysis of MAC we take dynamic effects indirectly into account what enables us to give recommendations for the promotion of renewables in the presence of ETS.