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In markets where consumers face volatile methane prices, researchers at the Massachusetts Institute of Technology (MIT) propose that increasing installation incentives may be the most effective way to maximize social good and mitigate long-term risks in U.S. electricity markets.
Economists, policymakers and energy professionals often debate the most effective instruments for deploying clean energy, usually focusing on carbon taxes or tax credits. While both have theoretical merits, only one has substantially boosted capacity deployment in the United States: the investment tax credit (ITC).
A recent analysis by researchers at the Massachusetts Institute of Technologys Center for Energy and Environmental Policy Research (MIT CEEPR) suggests that in electricity markets such as the US, where most consumers lack long-term fixed-rate contracts and are therefore at risk of market pricing, tax credits are the most efficient policy tool.
In the study, “ Choosing Climate Policies in a Second-best World with Incomplete Markets: Insights from a Bilevel Power System Model ,” the MIT CEEPR researchers propose that a solar ITC above 80% of system costs could optimize welfare-focused policy outcomes.
A key variable in this model is the volatility of natural gas (methane) prices, the main driver of electricity costs in the United States. Recent developments in Europe and the United States demonstrate that methane prices can spike due to factors such as geopolitical tensions, supply constraints, and market practices.
This instability directly affects all but the largest American consumers, and rising electricity prices are one example of this at California’s major utilities. In recent years, the state’s three largest electric companies have raised their retail rates by at least 47%, and San Diego Gas & Electric’s by 104%.
The MIT analysis indicates that because current market designs place most of the price risk on electricity buyers, while utilities can pass on costs to consumers through utility commissions, advance tax credits could significantly increase the adoption of renewable energy. This strategy becomes important as the U.S. government seeks to dramatically reduce emissions.
Under scenarios with aggressive emissions reductions, MIT analysis suggests that an optimal carbon tax could reach $800 per ton of CO2 emissions, with a solar ITC that could meet or exceed 80% of project costs.
Interestingly, while Americans are generally willing to support a carbon tax, they prefer that the revenue be earmarked specifically for the deployment of new clean energy technologies. This preference suggests that a carbon tax, if designed with public acceptance in mind, would be most effective if paired directly with a tool like the solar ITC.
The paper highlights that market pricing risk exists along a spectrum, with some groups, primarily large technology companies, having access to long-term agreements that stabilise energy prices.
Asked about the application of this analysis to the United States, where most consumers face fluctuating prices, one of the studys authors, PhD candidate Emil Dimanchev, told pv magazine :
In reality, market completeness (i.e. the adequacy of PPAs and other such contracts) is a spectrum. The reality is somewhere in the middle (there are some contracts) and we look at the extremes: full contracting versus no contracting. This at least allows us to see how market outcomes change *directionally*. Are emissions going up or down? Are there more or less clean energy investments? Essentially, this is a warning that current markets, where investment risk is borne mostly by big tech companies, will not incentivize the large amount of clean energy that governments want to decarbonize electricity.
The analysis shows that in full markets, where all long-term electricity pricing risk is hedged and predictable, a carbon tax is theoretically the most cost-effective policy. However, in “missing markets,” where there is no long-term hedge or fixed contracts, the CTI is more efficient. In the long term, when the country aims to achieve very low emissions levels, the study concludes that a combination of CTI and carbon taxes would yield the most efficient results. |
