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Electricity capacity investment under risk aversion: A case study of coal, gas, and concentrated solar power

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  • Fan, Lin
  • Norman, Catherine S.
  • Patt, Anthony G.

Abstract

The policy instrument many economists favor to reduce greenhouse gas emissions and to shift new investment towards low carbon technologies is the tradable allowance system. Experience with this instrument has been mixed, with a crucial design issue being the choice of whether to auction allowances to firms, or to grandfather them based on historical emissions. In this paper, we examine the changing incentives of investment in different technologies, when investors are risk averse and are expecting an allowance system with a certain allocation rule but do not know if the policy is going to take place in the near future. Investors also cannot fully predict future investment costs for the low-carbon technology. We apply a game theoretic model to examine the combined effects of uncertainty and risk aversion on the actions of potential investors into high and low carbon generating capacity, under both allocation rules and uncertain costs. We find that uncertainty and risk aversion do have implications towards investment incentives. We discuss policy implications of these findings.

Suggested Citation

  • Fan, Lin & Norman, Catherine S. & Patt, Anthony G., 2012. "Electricity capacity investment under risk aversion: A case study of coal, gas, and concentrated solar power," Energy Economics, Elsevier, vol. 34(1), pages 54-61.
    • Handle: RePEc:eee:eneeco:v:34:y:2012:i:1:p:54-61
    DOI: 10.1016/j.eneco.2011.10.010
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    Cited by:

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    6. Milstein, Irena & Tishler, Asher, 2015. "Can price volatility enhance market power? The case of renewable technologies in competitive electricity markets," Resource and Energy Economics, Elsevier, vol. 41(C), pages 70-90.
    7. George A. Gonzalez, 2016. "Transforming Energy: Solving Climate Change with Technology Policy . New York : Cambridge University Press . 360 pages. ISBN 9781107614970, $29.99 paperback. Anthony Patt , 2015 ," Review of Policy Research, Policy Studies Organization, vol. 33(1), pages 111-113, January.
    8. Fraunholz, Christoph & Miskiw, Kim K. & Kraft, Emil & Fichtner, Wolf & Weber, Christoph, 2021. "On the role of risk aversion and market design in capacity expansion planning," Working Paper Series in Production and Energy 62, Karlsruhe Institute of Technology (KIT), Institute for Industrial Production (IIP).
    9. Perica Ilak & Lin Herenčić & Ivan Rajšl & Sara Raos & Željko Tomšić, 2021. "Equilibrium Pricing with Duality-Based Method: Approach for Market-Oriented Capacity Remuneration Mechanism," Energies, MDPI, vol. 14(3), pages 1-19, January.
    10. Taylor, Benjamin & Xiao, Ning & Sikorski, Janusz & Yong, Minloon & Harris, Tom & Helme, Tim & Smallbone, Andrew & Bhave, Amit & Kraft, Markus, 2013. "Techno-economic assessment of carbon-negative algal biodiesel for transport solutions," Applied Energy, Elsevier, vol. 106(C), pages 262-274.
    11. Baiardi, Donatella & Manera, Matteo & Menegatti, Mario, 2014. "The Effects of Environmental Risk on Consumption: an Empirical Analysis on the Mediterranean Countries," Energy: Resources and Markets 172443, Fondazione Eni Enrico Mattei (FEEM).
    12. Koltsaklis, Nikolaos E. & Dagoumas, Athanasios S., 2018. "State-of-the-art generation expansion planning: A review," Applied Energy, Elsevier, vol. 230(C), pages 563-589.
    13. Chen, Huadong & Wang, Can & Cai, Wenjia & Wang, Jianhui, 2018. "Simulating the impact of investment preference on low-carbon transition in power sector," Applied Energy, Elsevier, vol. 217(C), pages 440-455.
    14. Bublitz, Andreas & Keles, Dogan & Zimmermann, Florian & Fraunholz, Christoph & Fichtner, Wolf, 2018. "A survey on electricity market design: Insights from theory and real-world implementations of capacity remuneration mechanisms," Working Paper Series in Production and Energy 27, Karlsruhe Institute of Technology (KIT), Institute for Industrial Production (IIP).
    15. Christian Winzer, 2013. "Robustness of Various Capacity Mechanisms to Regulatory Errors Abstract: In the EU, several governments have introduced or are contemplating a capacity mechanism to ensure adequate investment in gener," Cambridge Working Papers in Economics 1338, Faculty of Economics, University of Cambridge.
    16. Ernesto Garnier & Reinhard Madlener, 2016. "The Influence of Policy Regime Risks on Investments in Innovative Energy Technology," The Energy Journal, , vol. 37(2_suppl), pages 145-160, June.
    17. Christoph Fraunholz & Kim K. Miskiw & Emil Kraft & Wolf Fichtner & Christoph Weber, 2023. "On the Role of Risk Aversion and Market Design in Capacity Expansion Planning," The Energy Journal, , vol. 44(3), pages 111-138, May.
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    More about this item

    Keywords

    Emissions trading; Allowances; Allocation rules; Uncertainty; Risk aversion;
    All these keywords.

    JEL classification:

    • L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance
    • L9 - Industrial Organization - - Industry Studies: Transportation and Utilities
    • Q2 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Renewable Resources and Conservation
    • Q4 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy

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