RPS and Electricity Prices

One of the most important energy-related trends at the state level is the imposition of renewable electricity mandates. Currently 29 states have passed these mandates and another 7 states have enacted renewable electricity goals. Many in Congress are pushing the federal government to follow suit and enact a nationwide renewable electricity mandate. To date, no studies have looked at the impact of these mandates on electricity prices. A forthcoming study from the Institute for Energy Research will examine these mandates and their impact on electricity prices. In this post we summarize the connection between renewable mandates and higher electricity prices.

Economic Theory Says Renewable Mandates Will Lead to Higher Electricity Prices

Currently 29 states have some type of renewable mandate, meaning that their legislature requires that a certain percentage of electricity be produced from “renewable” sources. The specific targets, timelines, and even definition of “renewable” vary from state to state. But the common theme is that many state governments use their power to push their electricity sectors away from a purely market-driven outcome.

Economic theory predicts that, other things equal, government mandates requiring a higher percentage of “renewable” electricity sources will lead to higher prices. After all, the reason the market avoids such sources in the first place, is that there is some drawback making them less attractive than sources considered “non-renewable” (such as those based on fossil fuels).

Left to its own devices, the free-market economy tends to deliver the highest quality products and services, at the lowest possible prices, to consumers. If the government declares that this market-based outcome is now illegal, and requires electricity providers to alter their business models, then something has to give. Once the industry settles into a new equilibrium, we would expect to see higher retail prices for consumers, to reflect the fact that the government forced providers into using techniques that would not be profitable on the open market.

In Actual Practice, Renewable Mandates Associated With Higher Prices

If we compare 28 states with renewable mandates, against 19 states with no mandate,[i] we find that average electricity prices are 38 percent higher in the first group:

Now it’s true, we cannot say that these large price differentials are due entirely to the imposition of renewable mandates. For one thing, state legislatures that impose such mandates, probably are more likely to impose other inefficient policies as well, which contribute to higher prices. It is also possible that states with access to low-cost sources (fossil fuels and large, existing hydroelectric) enjoy lower average electricity prices, and precisely for that reason their legislatures are not as likely to impose renewable mandates.

Isolating the Impact of Renewable Mandates

To minimize the problems of causation versus correlation noted above, we conducted another test. Rather than focusing on recent price data, we looked at energy prices between our two test groups for the year 1997, the latest year in which the modern renewable mandates did not exist. We found that the first group of states (i.e. the 28 that currently have renewable mandates) even then had higher energy prices across the board. The crucial point however is that the difference was smaller than in June 2010:

This second table illustrates that something caused the price gap to increase between the two sets of states, during the time in which the renewable mandates were introduced.

Conclusion

Economic theory suggests that imposing renewable energy mandates will tend to raise electricity prices. State-level data are consistent with this result: States with renewable mandates have much higher prices than those without such mandates. It is true that only a portion of this differential can be attributed to renewable mandates. Even so, legislators at both the state and federal levels should consider the full economic impact of their policy decisions. Attaining higher proportions of “renewable” energy may not come cheaply.

[i] The states of Hawaii, Alaska, and Vermont were excluded from the two categories. Vermont has a unique hybrid RPS, while Hawaii and Alaska are obviously special cases and could skew the averages without shedding much light on the effects of renewable mandates.