The Economic Effects of Interregional Trading of Renewable Energy Certificates in the U.S. WECC.

Author:Perez, Andres P.

    Climate change concerns have been instrumental in driving regulatory policies that seek to reduce emissions and promote increasing amounts of generation from renewable resources (Kung, 2012). Policies that explicitly promote production from renewable generation technologies include Renewable Portfolio Standards (RPS), Feed-in Tariffs (FITs), and Renewable Auction Mechanisms (RAMs) (Perez de Arce and Sauma, 2016). Other environmental policies, such as carbon taxes or cap-and-trade programs, aim at reducing greenhouse gas emissions and do not specify renewable targets. However, emissions policies indirectly incent generation from renewable resources by making some conventional technologies less competitive (Fischer and Newell, 2008). This article focuses solely on the effects of varying RPS policy designs across several independent but neighboring jurisdictions.

    An RPS is a market-based regulation that requires electric utilities and other load-serving entities (LSEs) within a region to supply a fraction of their energy from qualifying renewable resources within a compliance period. To date, 30 states in the U.S. have enacted binding renewable mandates while 7 others have created voluntary state renewable goals (US DSIRE, 2013). Some expectations for adopting these policies include reductions of in-state greenhouse gas emissions, improvement of competitiveness, diversification of fuel sources, job creation, and stabilization of electricity prices (Holt and Wiser, 2007). Although some observers have questioned whether RPS policies are the most cost-effective way to meet these economic and environmental objectives (Lyon and Yin, 2010), RPSs have been the most popular renewable policy in the U.S. for the last two decades (Wiser et al., 2007).

    A distinctive feature of RPS policies is their flexibility. Most implementations allow LSEs to meet their renewable targets through ownership of an equivalent number of Renewable Energy Credits (RECs), which are financial instruments that represent the environmental attributes of electricity generated using renewable energy technologies. A REC is created from the generation of one megawatt-hour (MWh) of energy from an eligible resource and can be traded as a commodity, separately from the electricity itself (Barry, 2002). Through this certificate trading mechanism, LSEs that fall short of the minimum number of RECs required by the RPS can still meet the mandate by purchasing certificates from eligible LSEs that hold RECs in excess of their target (Elder, 2007; Cory and Swezey, 2007). The trading eligibility of the RECs from out-of-state LSEs varies from one state to another.

    On one hand, virtually all states having RPS policies allow for unlimited use of out-of-state RECs provided that the underlying electricity is delivered into the state. These are called "bundled RECs" because they correspond to out-of-state RECs that require deliverability of the electricity into the state. A MWh is generally deemed delivered in Western Electricity Coordinating Council (WECC) if the power is moved by "dynamic transfer" (1) in which some generation or other resource in the receiving region is controlled so that it compensates for fluctuations in the output of the renewable source. This requires sophisticated communications and control systems, and results in varying and perhaps inefficient use of interties between the source and sink balancing authorities, in that intertie capacity with a positive shadow price in the day-ahead market might then go unused in real-time. The transaction costs involved in dynamic transfers therefore are a recognized barrier to importing bundled renewables, especially from distant balancing authorities, and policy makers have been considering methods to lower those costs (RAP, 2012; Coffee et al., 2013).

    However, only some states allow for "unbundled RECs"; that is, out-of-state RECs that do not require deliverability into the state. By allowing utilities to meet a fraction of the RPS goal with out-of-state unbundled RECs, states aim to further reduce the expense of meeting the RPS regulation. Unbundled RECs allow LSEs to take advantage of the most cost-efficient renewable resources available for deployment, independent of location. Consistent with the tradeable RECs approach, the European Union is currently studying the replacement of national renewable targets with an overall European goal after 2020 (Castle, 2014).

    Although unbundled RECs have the advantage of allowing exploiting the most cost-efficient renewable resources available for deployment, each state has its own reasons to restrict the eligibility of out-of-state resources. Accordingly, it is important to acknowledge the policy objectives that have driven states to restrict eligibility of out-of-state resources, such as local economic development and reduction of local pollution. Furthermore, there are several legal challenges that have arisen with respect to these restrictive provisions (related to the commerce clause of the U.S. constitution, for example). In summary, there are several issues that states must weigh, beyond just the economic impacts, when considering how to implement their RPS policies.

    On the other hand, empirical and theoretical studies have found that RECs and other sources of flexibility in emissions policies may have unintended consequences on electricity markets and the environment (Bushnell et al., 2008). For example, a lack of coherence in the geographic scope of regional electricity markets and cap-and-trade programs can result in short-run displacement of C[O.sub.2] emissions from a capped region to uncapped regions, which could increase aggregate emissions (Chen, 2009; Sauma, 2012). It has also been shown that firms that own efficient generation technologies have economic incentives to withhold emissions permits to increase their market share in the electricity market (Limpaitoon et al., 2014). Yet, little research has been conducted on the economic effects of RPS designs that incorporate flexible REC trading schemes, and the few existing studies are mostly qualitative.

    Mozumder and Marathe (2004), for instance, describe the benefits and challenges of integrated REC markets in Australia and Europe. Meanwhile, in the U.S., Mack et al. (2011) discuss limitations that some states impose on LSEs regarding RECs obtained from other states. They conclude that limiting the geographical eligibility of RECs leads to both more volatile and less liquid markets for RECs. Berendt (2006) and Sovacool (2011) reach a similar conclusion and propose a national trading platform for renewable certificates that would deepen REC market liquidity. All of the foregoing studies disregard the effects that transmission congestion and costs may have on the outcomes of the renewable policies. As noted by Kahn (2010), the cost of transmission needed to integrate renewables could be nearly four times the cost of ancillary services used to back up these generation technologies. In particular, the California Public Utilities Commission estimates that transmission investments required to meet the 33% state RPS by the year 2020 will cost approximately $16 billion, which is double the annual wholesale cost of electricity of the California ISO in 2011 (CPUC, 2009).

    To the best of our knowledge, there are only three studies that have explicitly considered the interaction between the design of RPS policies and transmission infrastructure investment cost. Using an aggregated regional-based model of the U.S. electric power system, Vajjhala et al. (2008) evaluate the effects that state RPSs--or a hypothetical federal renewable mandate--would have on interregional power flows, as well as on transmission and generation investments needed to meet the targets. They find that a federal RPS would significantly change the geographical distribution of investments compared to a set of state targets that can be met only by in-state resources. Munoz et al. (2013a) utilize more detailed network models to analyze the impact of different RPS designs in transmission planning. They find that ignoring Kirchhoff's Voltage Laws (KVLs) or transmission investment indivisibilities can significantly bias investment portfolios for their hypothetical network. Munoz et al. (2013b) propose a stochastic investment-planning model that co-optimizes transmission and generation investment. They represent long-term market and regulatory uncertainties with different scenarios of state and federal environmental policies. As with Vajjhala et al. (2008), they conclude that federal and state regulations require distinct investment portfolios to meet the renewable targets at minimum cost for consumers. However, none of the previous studies quantify the economic and environmental effects of RPS designs that include flexible unbundled REC trading schemes.

    As mentioned earlier, trading of RECs among regions to meet RPS targets might be expected to have a positive aggregate impact, but there is less certainty about the magnitude of the benefits and the effects of such trading on infrastructure investments, C[O.sub.2] emissions and energy prices. In this article we quantify the economic benefits of allowing increased trade of unbundled RECs among states in the WECC in order to meet their renewable targets. (2) We utilize a planning model that co-optimizes the portfolio of transmission and generation investments simultaneously. Our model accounts for realistic features that are often overlooked in high-level energy-economic models for policy analysis, including transmission investment indivisibilities, the variability of renewable resources, and parallel-flow effects due to Kirchhoff's Laws. (3) Assuming projected state renewable targets, we study the impact of different degrees of REC trading flexibility upon the total system cost and infrastructure investments using a 240-bus network reduction of the WECC. We also measure...

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