Click here for part 1, and here for part 2.

The California utility commission has created a program where the renewable energy producer who offers the lowest sales price for renewable energy will be guaranteed that price throughout the life of the contract. This price will still be higher than the going rate for electricity on the open market. What does the difference between the renewable energy price and the regular energy price tell us, and how can it be applied to a cap and trade system?

Let's take the concept of the California program and move it to an electricity market I know a little more about, Houston. Clearly, the point of the program is to incentivize the generation of renewable electricity. But the same goal could be achieved by taxing electricity that generates carbon. If we assume that the price of electricity is 10 cents/kWh, and the renewable feed-in tariff will be 2 cents/kWh, then we could achieve the same goal of promoting renewable power by levying a tax on non-renewable power. As long as the tax was higher than 2 cents, it would be cheaper to purchase the renewable energy.

Every area has its own mix of power sources: coal, oil, natural gas, nuclear, hydro, and renewable. The particular mix of power sources will dictate how much carbon is in the baseline available electricity. In Harris County, an average 1000 kWh of electricity produces 990 lbs of CO2. Or, to flip it: 1 ton of CO2 is generated by 2,018 kWh of electricity.

The program with my assumed prices (we don't actually know what the premium for renewables will be yet) is that the carbon-free power costs 2 cents more per kWh, then we have learned that the externality cost of a ton of CO2 is approximately $40.

Now here's the problem with a feed-in tariff: it affects producer behavior but not consumer. The utility commission will raise the money to pay the feed-in tariff by charging all of its customers a fee. It is, essentially, a small carbon tax.

Why not bypass the whole feed-in tariff concept and begin taxing carbon directly? A true carbon tax can incentivize not just renewable energy, but all kinds of steps to reduce carbon emissions. Carbon can be reduced through use of renewable energy, but also cleaner fossil fuels and carbon capture. Carbon reduction programs should be technology neutral.

Feed-in tariffs require regulatory agencies to pick winners and losers in technology. Cap and trade (which is really just another word for carbon tax) would allow innovation in any number of technologies, and let the market decide which one was best.