The optimal percentage requirement and welfare comparisons in a two-country electricity market with a common tradable green certificate system

The tradable green certificate (TGC) system, with its requirement for a percentage commitment to energy production from renewable sources, has become an important instrument in resolving greenhouse gas (GHG) issues and promoting the generation of sustainable energy. In this paper, based on the model of Aune et al. (2012) and the framework in Currier and Rassouli-Currier (2012), I analyze a competitive electricity market with two countries. I geometrically illustrate that under competitive equilibrium, variations in the renewable quota generate an “equilibrium locus” corresponding to the set of renewable/fossil fuel-based electricity supply and demand levels attainable across the two countries. With this concept, I further derive the pricing rule for TGCs when the percentage requirement is the only policy instrument and the regulator chooses it optimally to maximize welfare along the “equilibrium locus.” Using a geometric illustration, I compare the two countries' welfare when the renewable quota is chosen optimally in the common certificate market with three different situations, in particular: (i) before the introduction of a common TGC market when the renewable quota is chosen optimally; (ii) when all firms are fossil fuel energy producers and just produce the competitive equilibrium output; and (iii) when all firms are fossil fuel energy producers regulated by a CO2 emissions standard. I find that the total welfare with the optimal renewable share in a common certificate market is always greater than situations (i) and (ii), and is also greater than situation (iii) when damages by fossil energy producers are sufficiently bounded. Our policy recommendation is that when the value of the damage parameter is sufficiently small, full integration with a common TGC market is superior in terms of welfare to that of an entirely fossil fuel-based market with an optimal emissions standard. The numerical example demonstrates the welfare comparison results in the theoretical model.