Promotion of renewable energy: Higher welfare by lower depreciation costs for fossil power plants?

There is broad agreement that renewable energy sources (RES) will play an important role in mitigating climate change by abating CO₂ emissions. However, there is a contentious debate about the economic sense of a promotion of RES. According to static analyses, a pricing of emissions is a sufficient regulation to reduce emissions. Such works conclude that the promotion of RES ties up capital which could have been used more efficiently by other reduction strategies with lower marginal abatement costs (MAC). Dynamic models, in contrast, emphasize learning effects which lead to lower MAC of RES. In particular, start-up funding to induce an early market entry of RES may be advantageous to benefit from reduced MAC.

To our knowledge there has been little attention so far to the effects of renewables' promotion on the necessary shut down of power plants based on fossil energy sources (FES). With respect to the achievement of a certain long-term reduction objective (e.g. the EU objective to reduce CO₂ emissions to a level 80 – 95 % below the 1990 level) an early market entry of RES allows a longer transition from FES to RES. This also means that more time is available to shut down FES based power plants which may reduce respective depreciation costs.

We use an endogenous growth model of the Ramsey type to examine the impact of a promotion of RES. Our model on the one hand considers the described potential decrease of depreciation costs for FES based power plants. On the other hand it takes into account increased capital expenditures because of investments in a technology with higher MAC than necessary. In addition to labor and capital we introduce energy as a third state variable and input factor for the production of a generic good. Moreover we establish a long-term objective of emission reduction which can be achieved by pricing of emissions only (e.g. with an emissions trading system) or an additional promotion of RES. Although we do not consider learning effects of RES, we find that additional promotion of RES can increase welfare. This indicates a significant impact of reduced depreciation costs on overall mitigation costs. Consequently the significance of this result, in particular, depends on the rigor of the long-term objective of emission reduction.