ANNEX “A”

OPTIMAL PENETRATION APPROACH

CONCEPTUAL FRAMEWORK

In the basic economic theory, one prerequisite for economic efficiency is that
the marginal benefit of any given activity should be equal to its marginal cost.
With respect to the use of electricity, this would require that the marginal
social benefit (MSB, commonly defined as 'demand curve') attributed to the
consumption of, say, one kilowatt-hour of electricity, is exactly offset by the
marginal social cost (MSC, commonly defined as 'supply curve', incorporating
the cost of externalities) of generating this kWh, in order to achieve 'Pareto-
optimality’1. In all other cases, society would be better off providing and using
more (i.e., where MSB exceeds MSC) or less (i.e., where MSC exceeds MSB)
electricity.

In fact, when analyzing policies to promote RE, we should be more concerned

with the allocation of electricity generation amongst the various technologies,
such as RE and conventional sources of energy. In this respect, economic
efficiency would require that the marginal cost of producing the quantity QE*
be equalized amongst the sources, so that the marginal social cost of
conventional electricity generation (MSC(Con)) equals the marginal social
cost of RE generation (MSC(RES)) in QE*. This is known as the principle of
'equi-marginality' in the economic theory.

Exhibit 1 illustrates the equi-marginal principle. In this figure, QE denotes

the allocation of electricity generation between conventional and
renewable sources of energy, where the share is determined by the
respective marginal private costs for conventional energy (MPC(Con) -
red)). In contrast, the socially optimal allocation would be where marginal
social costs are equalized, i.e., at QE*, resulting in the relative shares
Q(RES) and Q(conventional), which is usually attained only when all
external costs are internalized. In other words, if specific policies are not
developed, the penetration of RE will reach only QE because the electricity
market is severely distorted in that external costs tend not to be
internalized; therefore, market regulation is justified on the grounds of the
normative theory.

                                                            
1
 An economic system that is Pareto‐optimal or Pareto‐efficient implies that no individual can be made better 
off without another being made worse off.  Here, ‘better off’ is often interpreted as “put in a more preferred 
position.”  It is commonly accepted that outcomes that are not Pareto‐optimal are to be avoided, and 
therefore Pareto efficiency is an important criterion for evaluating economic systems and public policies 

Page 1 of 20 

 
 Exhibit 1: Equi-marginal Principle Illustrated

Unfortunately, this seemingly simple framework is hard to translate into a

reliable cost-benefit test, since a large number of input parameters are at the
core of much of the academic debate, and other parameters are rather difficult
to assess; for instance, the use of a discount rate for costs and benefits, the
value of avoided external costs2, the potential for each technology and the
cost of specific installations, all have a great influence on the final verdict but
are rather difficult to quantify. This is why - as shown in Exhibit 1 - a bound of
prices and quantities is finally calculated.

Due to high uncertainty in setting the parameters required to compute these

supply curves (e.g., RE costs and potentials, technological progress in both
conventional and RES, discount rates, environmental costs, non-
environmental externalities, etc.), we are not able to set a single social supply
curve, but a probable range. Therefore, we are not able to define a single
optimum mix, but rather a space of potential first-best solutions, as defined by
the area 'abcd' in Exhibit 1. Consistently with this area solution, we find a
range of prices (PhP), and the corresponding shares Q(RES)
:Q(Conventional) can therefore vary a lot. Despite the inaccuracies of this type
of analysis, it is the best available tool to evaluate policy decisions either
within the solution area, or outside this. For instance, if we assume that the
government has decided to set a policy at PE*:QE*, which is a boundary point
solution for the first-best space of solutions, based on this model, we can
compute, amongst other interesting policy evaluations:

                                                            
2
 A very well known reference is the work by Sundqvist who found vast differences for external costs across 
externality studies, e.g., ranging from 0.06 cents/kWh for coal.  See Sundqvist, T. “What causes the disparity of 
electricity externality estimates?”, Energy Policy, Vol. 32, Issue 15, Elsevier Ltd., Amsterdam:  October 2004. 

Page 2 of 20 

 
 1. How different is that choice from the market outcome (natural
penetration) (PE:QE),

2. What RE technologies (and what range of these technologies) will be

developed under this single feed-in tariff (PE*), and

3. What is the cost of the policy to final customers (i.e., [PE* - PEl x [QE* -
QE]).

Therefore, although these kinds of studies can give us an overall idea of

where the optimal allocation can be found, in the real world the concept of
cost efficiency suggests that regulators set an objective based on available
scientific and technical data, and then try to ensure that this objective is met at
'least' cost. In doing so, policy makers make sure that, if efficiency cannot be
maintained in the strict economic sense, then at least, reaching the goal does
not result in a waste of the society's resources. The question then is how
policy makers can ensure cost-effectiveness in the expansion of RE on a
practical basis. The answer to this is surprisingly simple and though it is
related to implementation issues discussed in the next section, we can
anticipate that it comprises:

• Setting technology-wise installation caps (an amount of MWs to be

installed at an specific FIT) in order to analyse the feedback from
investors and manage the extra cost to final customers,

• Applying FITs lower or equal to PE* or the social avoided cost (if PE*
cannot be computed).

The problem with this approach is that policy makers may (1) not be
concerned solely with static efficiency, which does not take into account long-
term prospects and technological innovation, and (2) look at the effect on
social surpluses beyond the power market such as the manufacturing sector;
therefore they may define a policy decision outside the first-best space of
solutions in a partial equilibrium analysis. In Europe, it is understood that any
instrument to promote RE should also lead to 'dynamic efficiency', i.e., should
give economic agents an incentive to continuously lower their costs through
technological progress, as well as to develop a leading RE technologies
manufacturing sector. In that sense, single feed-in tariffs that are best for
static efficiency are replaced with targeted feed-in tariffs incorporating
technology-specific rates, in many cases higher than PE* or social avoided
costs.

Critical issues in developing this type of modeling are:

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 • General assumptions (target year, static or dynamic efficiency
considered, incremental or total modeling, etc.);

• Estimation of social and private supply curves (given costs or

probabilistic approach, potential estimation by RE class, discount rate,
monetarization of externalities, etc.); and

• Demand side perspectives (energy efficiency, demand forecasting, etc.).

 

GENERAL ASSUMPTIONS OF THE MODEL

The first task in developing the model is to set general assumptions

concerning most of the variables included in it. These assumptions comprise:

• Definition of the Target Year: The target year is usually defined

considering at least a 10-year period.

• Definition of the modeling approach: As mentioned, the model

can be defined as incremental or total. Incremental models are
better suited for evaluating the effect (penetration, prices and
burden) of RE policies. Under an incremental approach, the social
and private supply curves for both RE and conventional sources are
computed without considering the installed capacity in any type of
energy. Similarly, only the incremental demand (total demand
forecasted for the target year less the existing total demand) is
considered.

• Efficiency assessment: Static efficiency assessment is simpler

and requires less assumptions; static efficiency means that supply
curves are computed employing current costs for different
technologies. In some comparable studies, costs were forecasted
for the end of the analysis period (generally 2020 or beyond),
employing experience curves that describe how costs decline with
cumulative production. Forecasting technological development is a
crucial activity but not an easy one, especially for a long-term
horizon; considerable efforts have been made recently to improve
the modeling of technology development in energy models;
nevertheless, the introduction of this dimension adds other drivers
of uncertainty to the model. In general, an experience curve is
expressed as: CCUM (costs per unit as a function of output) = CO
(costs of the first unit produced) x CUM (cumulative production over

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 time) /\ b (experience index)3. The estimation of 'b' for each
technology is rather difficult and inaccurate. Besides these
problems, technological progress is not endless for each
technology; generally it presents an S-shaped curve. In our opinion,
the complexity and uncertainty regarding the incorporation of
technological progress to the model does not adequately trade off
with effort, but this approach penalizes infant technologies such as
solar PV and thermal and tidal and wave, for instance.

LONG RUN CONVENTIONAL AND RE SUPPLY CURVES

In general, renewable energy sources are characterized by a limited resource,

with output costs rising with increased utilization - as, for example, in the case
of wind power sites, where best wind conditions will be exploited first and, as
a consequence, once such options have been exhausted, the use of less
optimal sites will result in higher generation costs. A proper tool to describe
both costs and potentials is the (static) marginal cost-resource (or supply)
curve. In principle, a supply curve describes the relationship between
(categories of) technically available potentials (e.g., wind energy, hydropower,
biogas, etc.) and the corresponding (full) costs of utilizing this potential at a
certain point of time.

On the left-hand side of Exhibit 2, a continuous supply curve is depicted,

taking into account that every location is slightly different from the other
and, hence, looking at all locations - e.g., in that case, pre-feasibility
studies for about 100 small scale projects were available and thus a
continuous supply curve for small scale hydel energy emerges after the
expected energies for each project have been classified and sorted in a
least-cost way. The stepped function, as shown on the right-hand side,
represents a more practical approach, as in real life the accuracy needed
for a continuous design is impossible. Thereby, sites with similar economic
characteristics - e.g., in case of wind, sites with same range of fullload
hours - are described by one band and, hence, a stepped curve emerges
as shown in Exhibit 2.

Similarly, the conventional supply curve is calculated based on the

available expansion plan defined by the relevant national generation
planning authority

                                                            
3
 In many studies, a well‐known rule of thumb, empirically proven, is commonly employed:  costs decline by a 
constant percentage with each doubling of units produced. 

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 Exhibit 2: Real case example RE Supply Curve Computation

Exhibit 3: Small Hydro-based Power Supply Curve Exhibit 4: On-shore Wind-based Power Supply Curve

Two questions arise:

• Which cost should we employ? and

• How do we assess the potential?

As this is an incremental study, all plants will be new; in this case the
economic conditions are described by long run marginal costs (LRMC).
With respect to the potentials, OPTRES approach4 has provided the
soundest method for potentials: for new options, the additional achievable
medium-term potentials need to be assessed for each RE category at the
country-level, representing the maximal additional achievable potential up
to the target year under the assumption that all existing barriers can be
overcome and all driving forces are active; it represents the upper
boundary of what can be realized for a certain RE category. It is obvious
that for electricity generation a broad set of different technologies based on
RE exists today; a sound research study, exploring deeper into those
potentials which are more feasible in the medium term, would be required.
                                                            
4
 Report of the IEE projects OPTRES:  Assessment and Optimisation of Renewable Support Schemes in the 
European Electricity Market, February 2006. 

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 Exhibit 5: RE Potential Assessment (OPTRES approach)

As shown in Exhibit 5, the definition of the potential is not straightforward. At

least, four classes of RES potentials should be evaluated:

• Theoretical potential: For the theoretical potential to be derived,

general physical parameters have to be taken into account (e.g.,
based on the determination of the energy flow resulting from a certain
energy resource within the investigated region). This represents the
upper limit of what can be produced from a certain energy resource,
from a theoretical point of view - of course, based on current scientific
knowledge;

• Technical potential: If technical boundary conditions (i.e., efficiencies

of conversion technologies, overall technical limitations, as, for
example, the land area available for installing wind turbines) are
considered, the technical potential can be derived. Technical
potentials can be assessed in either a static or dynamic context, i.e.,
with increased R&D, conversion technologies might be improved upon
and, hence, the technical potential could increase;

• Realizable potential: The realizable potential represents the maximal

achievable potential assuming that all existing barriers can be
overcome and all driving forces are active. Thereby, general
parameters are taken into account, as for example, market growth
rates, planning constraints, etc.

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 • Medium-term potential: The medium-term potential is equal to the
realizable potential in the target year.

As mentioned earlier, computing the supply curves is a rather complex task,

requiring defining many aspects. For instance:

How to estimate proxy supply curves when information is not

fully available (project by project): In such cases the alternative is
to develop a probabilistic cost approach by simulating a large
number of scenarios and combining values for different key
parameters. In order to provide a more realistic simulation, each of
the available technologies (plant specifications for each step) can
be modeled using a different combination of values for the following
cost drivers: (1) investment costs; (2) fuel costs for some RE
bearing opportunity cost (biogas and biomass, for instance); (3)
efficiency factors in some types of RE; and (4) load factors.

Monetization of externalities for conventional and RE sources: As

mentioned before, it is estimated that the cost of electricity production
from coal and oil would double, and that of power production from gas
would increase by 30%, if externalities were considered. For the sake
of simplicity the following costs of externalities are considered: (1)
global environmental costs, (2) air quality, and (3) fuel dependency.

The cost of externalities affecting RE is generally discarded

because: (1) broadly speaking the cost for hydel projects does include
environmental and social costs when relevant; (2) they are negligible
for wind power (visual interference, noise, and bird deaths) and solar
thermal and photovoltaic (land use); (3) they are not relevant for other
RE technologies; and (4) if negative externalities are considered,
positive externalities, such as job creation and indigenous technology
development, should also be considered. The only case where it
makes sense considering externalities may be biomass, because of co-
firing.

Return of invested capital: From an economic point of view, the best

approach is to assume that investment is recovered within the lifetime
of the plant; plant lifetimes, in turn, depend on technology, ranging from
15 years for most RES-E technologies, to as much as 40 years for
hydel plants. However, this approach has a huge drawback as it does
not take into consideration the financial barriers to investment. As
private investors will eventually invest, payback periods and financing
constraints should be taken into account.

Page 8 of 20 

 
 Return on invested capital: Real market based WACC5 should be
employed.

Grid and reserves costs: The inclusion of the grid investment costs
depends on transmission connection regulation (deep, shallow, etc.)
but in any case it is a complex issue as it is project specific. The
simplest approach is to limit the analysis to potential installations less
than some few kms away from the existing transmission lines, and add
to the cost analysis a standard connection cost that, in turn, generates
an extra incentive for the installation of the plants closer to the grid.

As it is well known, some of the RE technologies are volatile in the short

term (non-firm energy) and therefore, the system requires both
operational and 'cold' reserves. Generally, this type of model does not
consider the cost of these backup reserves, as its determination would
require detailed simulations of the power system that are beyond the
scope of this type of modeling.

IMPLEMENTING THE APPROACH: EXAMPLE

a) Aggregated Supply curves

Once the social supply curves per each RE technology have been calculated,
the combined RE supply curve for the target year can be computed by adding
up the supply curves of each of the different technologies, re-ordering them
based on the economic merit order. As a consequence, a total incremental RE
supply curve can be estimated, as illustrated in Exhibit 6:

                                                            
5
 Weighted Average Cost of Capital 

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 Exhibit 6: Total RE-based Power Supply Curve

As it can be seen, based on this supply curve, the total medium-term potential
for RE-based on-grid power generation is around 55 TWh/year. The supply
curve is relatively low-stepped (from US$ 50jMWh to US$ 120jMWh) up to 50
TWh, and then becomes extremely steep because of the high cost of some
technologies and the higher extraction cost, part of different supply curves.
Note that the private and social supply curves are quite similar in the case of
RE technologies, as the only technology on which external cost has an
important effect is biomass (in this example, bagasse-based CHP).

The incremental private (without externalities) supply curve for conventional

energy is drawn based on future generation applying a simulation model for
least cost expansion for the target year. Two critical parameters are the
following: (1) the cost of different conventional technologies that can be
installed during the period, and (2) crude oil/coal price scenario. Final results
are quite sensible to the latter. As it was previously mentioned, the cost
figures for electricity production from coal and oil would be substantially
increased if externalities were taken into account. Therefore, their cost should
scale up due to externalities (global pollution, local pollution, security of
supply, etc.). Based on the simulation of an optimal generation expansion and
the assessment of externalities previously described, we may draw the private
and social supply curve for conventional energy target year, as shown in
Exhibit 7.

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 Exhibit 7: Private and Social Supply Curves for Conventional Energy for
2020

In this example, the analysis is simplified in order to get the main concepts
across, however, when doing it properly, peak and off-peak periods should be
discriminated, as (1) not all RE technologies can follow the load profile of
demand, and (2) avoided costs are quite different at different periods; but
conceptually, the approach is similar.

b) Assessment of Costs and Potential of RE Penetration under Different

Policies

b.1) Natural Penetration of Renewable Energy Sources

The first element that we need to identify is whether, under a private cost
analysis, there are economic signals that may foster the development of RE
in the event that all other barriers (administrative, regulatory, financial6 etc.)
are removed. The analysis is shown in Exhibit 8. This is similar to Exhibit 1,
but in this case the private supply curves, both for RE and conventional
energy, are the result of real estimations for the target year.
                                                            
6
 By financial barriers, we mean the case in which – from an economic point of view – some technologies could 
be developed but because, for example, or difficulties in the credit market, small producers cannot access the 
funds needed to develop these projects, and such opportunities are therefore not realized. 

Page 11 of 20 

 
 Exhibit 8: Optimal RES-E Penetration under Private Costs

In Exhibit 8, from the part (X:Y) where both supply curves meet each other, we
can get the optimal amount of RE penetration and the marginal cost of RE (the
cost of the last RE plant that is cheaper than the last conventional plant
replaced). In this case, we observe that the natural penetration of RE should
be around 17 TWh/year - which is around 7% of total power generation
expected in 2020 for the case under analysis. As we can see in Exhibit 9,
almost 60% of this share is comprised of hydel plants that are cheaper than
CCGT running on fuel oil (FO), which establish the price of avoided generation.
The other two RE technologies that should be developed are bagasse-based
CHP and other types of biomass.

This result shows that all future CCGTs running on FO should be replaced by
some RE, such as small-scale hydel and biomass. The fact that this energy is
not currently developed indicates that some barriers may exist, especially if
we consider that the marginal cost for RE is around US$ 75/MWh, and the
cost of generation based on FO exceeds US$ 125/MWh.

Another important piece of information that can be derived from Exhibit 8 is

the manner in which the avoided cost of generation based on FO is distributed
amongst different players when replaced by cheaper RES-E generation. The
avoided cost is distributed between:

• The cost of generation based on RE; and

• The surplus, which can be distributed between the producers and

consumers.
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 Exhibit 9: RES-E Technology-wise Penetration Under Private Costs

These three different areas are drawn in Exhibit 8 (colored bars) in order to
show how they are computed. The objective of a good renewable energy
policy is to maximize the total surplus, regardless of how this surplus is
distributed between producers and consumers. We will analyze in the
following sections how the distribution of the surplus depends on the designed
incentive mechanism. In this case, the generation cost of the REE plants that
replaced the CCGT (FO) is around US$ 1,020 million per year (2020), the
producer's surplus is US$ 235 million, and the consumer's surplus is about
US$ 1,025 million; therefore, total surplus is US$ 1,360 million. This means
that this society can gain up to around US$ 1,400 million per year if some of
the existing barriers - that are effectively blocking the effect of economic
signals - are removed.

b.2) Optimal Quota of Renewable Energy in 2020

A renewable energy policy should be based on a social assessment of costs

and benefits. The analysis given in the previous section does not consider
externalities; therefore, it forms a limited analysis meeting only minimum
requirements. In order to identify optimal penetration under proper social
assessment, the analysis performed in Exhibit 8 must be repeated, but this
time considering the social supply curves, both for RE and for conventional
energy. This is shown in Exhibit 10. In this case, we observe that optimal
penetration of RE should be around 25 TWh/year, which is around 10.3% of
total grid electricity generation expected in 2020. It can thus be surmised that

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market failure (resulting in externalities not being internalized) would hamper
the development of about 8 TWh/year (= 25 TWh/year - 17 TWh/year) of
renewable energy in 2020. To develop this extra 8 TWh/year, an economic
incentive mechanism is required, as it will be discussed later, assuming that
all other barriers to the development of the first 17 TWh of RES-E have
already been removed.

Exhibit 10: Optimal RE Penetration Under Social Costs

As we can see in Exhibit 11, under social cost assessment, not only hydel
and biomass plants but also biogas (farm slurries, sewage, landfills, etc.) and
wind power plants would be required to replace both CCGTs running on FO
and natural gas; as a matter of fact, most FO-based generation is replaced, as
well as around 15% of gas-based generation. The largest share of RE
generation is from hydel, like in the previous case, as small-scale hydel is the
cheapest option for developing RE here too. It is also important to note that
some RE technologies, such as solar PV or solar thermal, are not
economically feasible as on-grid solutions in current price/technology
conditions.

From Exhibit 10, we can compute the distribution of the avoided cost. In this
case, the cost of generation based on RE is around US$ 1,800 million per
year in 2020, and the total surplus stands at US$ 2,100 million per year in
2020. It is relevant to observe that total surplus increases by US$ 740 million
with respect to the natural penetration case. This implies that market failure
results in extracting around US$ 800 million per year from this society.

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 Exhibit 11: RES-E Technology-wise Penetration under Social Costs

b.3) Analysis of Single Feed-in Tariff Mechanism

The simplest RE incentive mechanism would be to set a single feed-in tariff -

that means establishing only one feed-in tariff for all technologies - at the
marginal cost of RE generation under the social cost assessment case, which
according to the analysis presented here, is US$ 103/MWh. This mechanism
should be equivalent to setting a quota at 10.3% of total generation in 2020.
The single feed-in tariff is said to have two mains drawbacks:

• It does not foster the development of certain technologies, basically

those technologies that are more expensive than the marginal cost of
supplying the optimal quota of RES-E in total generation (in this case, all
technologies with costs higher than US$ 103/MWh).
•
• It may generate high producer surplus - and, hence, decrease the
consumer's surplus, given a total surplus.

It must be made clear that, neither the first shortcoming nor the second are
disadvantageous from an economic point of view, as they are not related to
economic efficiency: the first one is about long-term industrial policy, while the
second relates to wealth distribution. The first shortcoming may be addressed
by analyzing how the total surplus is affected when industry-driven policies
are put in place. Regarding the distribution of the surplus, it is important to
observe that:

Page 15 of 20 

 
 • As a rule of thumb, multiple or technology-based feed-in tariffs tend to
reduce the producers' surplus, given a total surplus.

• A cost-plus approach, in which the cost is assessed for each plant,

under the hypothesis of no information asymmetry, makes the
producers' surplus tend to zero, maximizing the consumers' surplus.

• The producers' surplus is a consequence of the inframarginal rents.

Inframarginal rents can be observed in all markets, from cookies to
power pools, and represent a natural incentive for investors to perform
an activity.

• The amount of producer surplus depends on the slope of the RE supply

curve in the part that is lower than the conventional supply curve. The
higher the slope, the greater the producer's surplus. That is why it is
extremely important either to have an idea of the RE supply curve
before designing an incentive mechanism for RE, or defining installation
caps.
 

b.4) Analysis of Technology-based Feed-in Tariff Mechanism

Three different cases can be simulated in order to identify changes in total

surplus and in its distribution between producers and consumers:

• Optimal quota-constrained analysis-cost-efficient case: In this

case, we assume the same technologies, and the same
penetration for each RE, as we did under the optimal quota
analysis, but shifting from a single feed-in tariff to multiple feed-in
tariffs.

• Optimal quota-constrained analysis-industry policy-driven

case:
In this case, the same penetration (10.3%) for RE is considered, but all
RE technologies are taken into account, including those that do not
qualify under the optimal quota analysis. Therefore, the total RE amount
is the same, but the composition of the portfolio is different.

• Exhausting the medium-term potential: In this case, we define a

set of feed-in tariffs that serve as an economic signal for producing
about 55 TWh of renewable energy, instead of 25 TWh that is
implicit in the optimal quota.

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Except for the first case, the proposed alternatives are not cost-efficient and,
hence, it can be expected that the total surplus will be lower under the two
latter cases.

b.4.1) Optimal Quota-constrained Analysis: Cost-efficient Case

In Exhibit 8 we can see the feasible RE portfolio under an optimal quota

analysis. From the RE supply curve, we can compute which is the more
expensive plant for each technology cheaper than US$ 103/MWh. The costs
of these plants would be the feed-in tariff (FIT) for each RE. The feed-in tariffs
for each RE generation technology are shown in Exhibit 12.

The feed-in tariff for each technology is generally lower than the single feed-in
tariff, as expected, and hence the producers' surplus is lower. In effect, the
producers' surplus decreases from US$ 795 million to US$ 638 million, but the
total surplus remains the same - US$ 2,089 million. Thus, there is an increase
in the consumers' surplus of around US$ 157 million. Multiple feed-in tariffs
stand for an adequate trade-off for allocating the producers' surplus, as they
transfer a share to the consumers but ensure that the producers' surplus
remains high enough to be able to attract investors.

Exhibit 12: Producer Surplus under Multiple Feed-in Tariffs (Cost-efficient

Approach)

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 b.4.2) Optimal Quota-constrained Analysis: Industry Policy-driven
Case

In this case, we simulate the situation in which all RE technologies must be

installed. The penetration for each RE was computed by multiplying the medium-
term potential for each RE times the factor 'optimal quota/medium-term potential',
which in this case is 45%. The feed-in tariff for each RE is computed considering
the cost of the most expensive plant required to cover the necessary energy from
each RE. For instance, in the case of small-scale hydel, the penetration under
the optimal quota analysis is about 11.3 TWh, while under the current case it is
3.7 TWh; the cost of the most expensive plant to cover 11.3 TWh per year of
generation is US$ 103.3/MWh, but the cost of the most expensive plant to cover
3.7 TWh per year of generation is US$ 54.1/MWh. The other feed-in tariffs (FITs)
are computed in a similar fashion. In Exhibit 13, the FITs for each RES-E are
shown.

Exhibit 13: Surplus under Multiple Feed-in Tariffs (Industry Policy-driven

Approach)

It is important to note that, in this case, cheap energy (small-scale hydel, for
instance) is replaced by more expensive energy, such as solar PV, solar
thermal, or waste-to-energy. This makes the total surplus decrease from
US$ 2,089 million to around US$ 1,100 million. Within the power sector, this
policy would reduce wealth by about US$ 1,000 million every year, which is
supposed to be created in another area, for instance, through the
development of a local solar PV industry. The most affected agents are the
producers using the cheapest technologies, who stand to lose around US$
400 million per year as a result of such a policy. As it can be seen in Exhibit
13, the total surplus decreases because the cost of RES-E based
generation increases in the same proportion.

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 b.4.3) Exhausting the Medium-term Potential

In this case, we simulate that the total medium-term RE-based generation

potential - 55 TWh - utilizing all RE technologies, must be installed. Each
RES-E technology's penetration is the corresponding total medium-term
potential estimated in this study. The feed-in tariff for each RES-E
technology is based on the cost of the most expensive plant necessary to
cover the medium-term potential. The only exception is the case of small-
scale hydel that has been capped at US$ 103.3/MWh, because from this
point the supply curve becomes extremely steep and, hence, the
inframarginal rent for adding only 400 GWh of generation per year becomes
huge. The feed-in tariffs for the different RE technologies can be seen in
Exhibit 14.

Exhibit 14: Surpluses Under Multiple Feed-in Tariffs Exhausting

Medium-term RES-E Potential

Installing 55 TWh of RE generation - about a 22% quota with respect

to total generation in 2020 - is not efficient from an economic point of
view, because in this case cheaper conventional energy is replaced by
RE technologies that are extremely expensive. This is notable in the
change of the total surplus, which decreases from US$ 2,089 million
per year in the cost-efficient case down to about US$ 120 million. As a
matter of fact, the consumers' surplus becomes negative; this is
definitely not a convenient situation for consumers. The cost of
generation based on RE increases from US$ 1,800 million up to
around US$ 6,500 million, and we find a positive producers' surplus of
about US$ 1,240 million per year in 2020.
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 This type of analysis allows us to understand the economics of the
policy under a partial equilibrium approach, therefore, even when this
type of studies is not accurate due to the type of information and
assumptions it requires, it generates the quantitative bounds for policy
making. If information is not available, other approaches can be
defined for setting FITs but this type of analysis shows us that the
definition of prices and quantities when information is not available
should follow an iterative approach of installation caps to avoid large
social deficits.

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