The Incentive Consequences from Extending Renewable Energy Certificate Schemes to Pre-Existing Hydroelectric Facilities

Implementing new environmental policies or schemes require rulings on the eligibility criteria for incumbent facilities – which often differ to the rules for new facilities. We examine the eligibility rules covering pre-existing hydroelectric facilities under Australia’s Renewable Energy Target. Here, pre-existing renewable generators can earn renewable energy certificates (RECs) for production during a calendar year that exceeds a fixed annual baseline. We find evidence that this mechanism incentivizes the amplification of variation in year-to-year hydroelectric production, reflecting profit-maximizing behavior by firms to have years with low levels of production (earning no RECs, but storing additional water in dams) followed by years with relatively high levels of production (releasing more water to earn extra RECs). We further document that the year-on-year production distortions are offset by fossil-fuel production, but in a manner that has the potential to increase carbon emissions. We discuss motives for including pre-existing facilities in such a scheme, and options for removing the non-linearity of the policy rule that drives the existing year-to-year operating incentives. JEL Classification: L94 Electric Utilities; Q41 Energy: Demand and Supply; Prices; Q42 Alternative Energy Sources; Q48 Energy: Government Policy; Q58 Environmental Economics: Government Policy; Distributional Effects; Employment Effects; Size Distribution of Firms