On the Design of Distributed Generation Policies : Are Common Net Metering Policies Optimal?

Electricity customers who install solar panels often are paid the prevailing retail price for the electricity they generate. We show that this rate of compensation typically is not optimal. A payment for distributed generation (w) that is below the retail price of electricity (r) often will induce the welfare-maximizing level of distributed generation (DG) when centralized generation and DG produce similar (pollution) externalities. However, w can optimally exceed r when DG entails a substantial reduction in externalities. We demonstrate that the optimal DG compensation policy varies considerably as industry conditions change, and that a requirement to equate w and r can reduce aggregate welfare substantially and can generate pronounced distributional effects