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Renewables and Carbon Markets

Allowance structures will influence project economics.

Fortnightly Magazine - May 2009

them to continue operating on the margin. Allowing renewable installations to profit from selling offset credits arising from displaced power, coupled with permitting the fossil-based generator to retain monetary value associated with the displaced allowances, results in double counting from a carbon-accounting perspective. Because increased renewable energy will free up allowances, issuing offset credits to these facilities would result in two permits—the allowance and the credit—entering the market for every ton of reduced emissions. Emissions would rise above the cap instead of staying even with it. Therefore, rewarding the renewable facility for emissions reductions achieved under a system cap is technically flawed.

Renewable energy installations can, however, benefit from allocation of carbon allowances. As most renewable energy projects are non-emitting (the notable exception being biomass) and do not need allowances for compliance, owners of these installations could sell any carbon allowances they receive to entities with carbon-compliance obligations.

Allowance allocation decisions can benefit renewable energy entities either through receiving subsidies funded from auctioning allowances or by receiving allowan-ces outright. This can happen in three ways:

• Renewable energy installations could receive carbon allowances through a set-aside, meaning a portion of the total allowances created by the government would be set aside and granted to renewable energy installations based on a predetermined formula set by the government.

• An allocation formula based on electrical output (as opposed to historic emissions) could be used. While similar to a set-aside, allocation based on electrical output is insulated to some degree from political interference because a tangible metric is used ( e.g., megawatt-hours of electricity produced) to determine the number of allowances received.

• Renewable energy projects can receive subsidies funded through revenue recycling of allowance auction proceeds, if auctions are present in the eventual legislation. This can benefit renewable energy through a direct cash subsidy or by funding tax credits or other fiscal mechanisms designed to stimulate renewable energy investment.

Regardless of the manner in which renewable energy installations receive carbon allowances, each of these scenarios are subject to policy risks as they will be subject to periodic review and approval by a governmental entity.

Green Value

Under a cap-and-trade system, renewable energy installations only can participate in carbon trading if they receive allowances allocated to them by the government. They will not be able to generate carbon-offset credits. This distinction is important because future carbon values for renewable energy will be fundamentally tied to political decisions, and that exposes renewable projects that rely on assumptions of future carbon revenue to considerable carbon-policy risk.

Apart from carbon trading, renewable energy development is more likely to be stimulated by the effect carbon costs have on regional electricity rates. The degree to which carbon policies increases the cost of fossil-based generation will move forward the timing of grid parity for renewable-energy applications. This depends on the interface between the renewable technology considered, its application in the market and the underlying regional generation mix. In regions that are heavily reliant on carbon-intensive generation, investment in renewable generation could increase as a result of cost parity, not necessarily