Assessing carbon cap-and-trade policies on hybrid renewable energy investments: Implications for pricing and capacity decisions

Renewable energy sources such as solar and wind have received a lot of attention and research in recent years as the climate issue has become more serious. However, compared with traditional energy sources, renewable energy has unstable characteristics such as intermittency. Integrated systems consisting of two or more renewable energy systems, also known as hybrid renewable energy systems, are increasingly popular among environmentalists because their sources can complement each other and provide customers with higher quality and more reliable power than single-source systems. This paper develops an analytical framework to explore the impacts of carbon cap-and-trade policy on the pricing and capacity establishment decisions of a utility firm that invests in hybrid renewable energy (solar energy and wind energy) systems. Three carbon reduction mechanisms are considered: the No cap-and-trade mechanism, Grandfathering mechanism, and Benchmarking mechanism. We focus on the optimal investment decision of a monopolistic utility firm in a hybrid renewable energy system under such three mechanisms. We derive the equilibriums of the utility firm that invests in two renewable energy capacities and compare the performances of the three mechanisms. We find that, in terms of reducing carbon emissions, Grandfathering mechanism dominates the Benchmarking mechanism, but in terms of improving the firm's utilization efficiency of renewable energy power generation or the firm's investment in renewable energy, Benchmarking mechanism is preferred. Therefore, governments/regulators should fully consider how to use the cap-and-trade policies to guide firms to effectively reduce total carbon emissions, and provide different carbon policies for different purposes.