The Design of Renewable Fuel Mandates and Cost Containment Mechanisms

Policymakers typically favor renewable fuel mandates over taxes and cap-and-trade programs to reduce greenhouse gas emissions from transportation fuels. However, delays in the development and deployment of new technologies when binding mandates exist for their use may lead to situations with high short-run compliance costs. We study the effects and efficiency of two mandates, a renewable share mandate and a carbon intensity standard, with and without a cost containment mechanism. Using both a theory model of a regulated fuel industry and a numerical model of the U.S. fuel market, we show that whenever the marginal cost of renewable fuels is high relative to fossil fuels, cost containment mechanisms have the benefit of both constraining compliance costs and limiting deadweight loss. According to our numerical results, an optimally set mandate alone leads to only modest gains over business as usual welfare levels. However, the efficiency of both policies increases substantially when they are combined optimally with cost a containment mechanism