On the Optimal Design of Distributed Generation Policies: Is Net Metering Ever Optimal?

Electricity customers who install solar panels often are paid the prevailing retail price for the electricity they generate. We show that this "net metering" policy typically is not optimal. A payment for distributed generation (w) that is below the retail price of electricity (r) 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 policy varies considerably as prevailing production technologies change and that a restriction to net metering policies can both reduce aggregate welfare and have substantial distributional effects.