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Investment risk and return under renewable decarbonization of a power market

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  • Jos� I. Mu�oz
  • Derek W. Bunn

Abstract

How does financial performance risk affect investments in low-carbon electricity-generating technologies to achieve climate policy targets? A detailed risk simulation of price formation in the Great Britain wholesale power market is used to show that the increasing replacement of fossil facilities with wind, ceteris paribus , may cause a deterioration of the financial risk-return performance metrics for incremental investments. Low-carbon investments appear to be high risk, low return, and as such may require a progressively higher level of support over time than envisaged by the conventional degression trajectories. The increasing riskiness of the wholesale market will to some extent offset the benefits of lower capital costs and operational efficiencies if investors need to satisfy cautious debt coverage ratios alongside positive expected returns. This increased risk is additional to the well-known 'merit order effect' of low-carbon investments progressively depressing wholesale prices and hence their expected investment returns. Policy relevance Policy support for renewable technologies such as wind is usually based upon levelized costs and is expected to reduce over time as capital costs and operational efficiencies improve. However, levelized costs do not take full account of the risk aversion that investors may have in practice. Expected policy support reductions may be moderated to some extent by the increased financial performance risk that intermittent technologies bring to the power market. The annual risk-return profiles for incremental investments deteriorate for all technologies as wind replaces fossil fuels. This extra risk premium will need to be incorporated into evaluating policy incentives for new investments in a decarbonizing power market.

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  • Jos� I. Mu�oz & Derek W. Bunn, 2013. "Investment risk and return under renewable decarbonization of a power market," Climate Policy, Taylor & Francis Journals, vol. 13(sup01), pages 87-105, March.
    • Handle: RePEc:taf:tcpoxx:v:13:y:2013:i:sup01:p:87-105
    DOI: 10.1080/14693062.2012.750473
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    1. Gómez, Antonio & Zubizarreta, Javier & Dopazo, César & Fueyo, Norberto, 2011. "Spanish energy roadmap to 2020: Socioeconomic implications of renewable targets," Energy, Elsevier, vol. 36(4), pages 1973-1985.
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    1. Tomosk, Steve & Haysom, Joan E. & Wright, David, 2017. "Quantifying economic risk in photovoltaic power projects," Renewable Energy, Elsevier, vol. 109(C), pages 422-433.
    2. Conor Hickey & Derek Bunn & Paul Deane & Celine McInerney & Brian Ó Gallachoir, 2021. "The Variation in Capacity Remunerations Requirements in European Electricity Markets," The Energy Journal, , vol. 42(2), pages 135-164, March.
    3. Higgins, P. & Li, K. & Devlin, J. & Foley, A.M., 2015. "The significance of interconnector counter-trading in a security constrained electricity market," Energy Policy, Elsevier, vol. 87(C), pages 110-124.
    4. Galina Chebotareva, 2018. "Methods for the Evaluation of the Competitiveness of Energy Companies," Economy of region, Centre for Economic Security, Institute of Economics of Ural Branch of Russian Academy of Sciences, vol. 1(1), pages 190-201.
    5. Hdidouan, Daniel & Staffell, Iain, 2017. "The impact of climate change on the levelised cost of wind energy," Renewable Energy, Elsevier, vol. 101(C), pages 575-592.
    6. Browne, Oliver & Poletti, Stephen & Young, David, 2015. "How does market power affect the impact of large scale wind investment in 'energy only' wholesale electricity markets?," Energy Policy, Elsevier, vol. 87(C), pages 17-27.
    7. McInerney, Celine & Bunn, Derek W., 2017. "Optimal over installation of wind generation facilities," Energy Economics, Elsevier, vol. 61(C), pages 87-96.
    8. Vögele, Stefan & Teja Josyabhatla, Vishnu & Ball, Christopher & Rhoden, Imke & Grajewski, Matthias & Rübbelke, Dirk & Kuckshinrichs, Wilhelm, 2023. "Robust assessment of energy scenarios from stakeholders' perspectives," Energy, Elsevier, vol. 282(C).
    9. Nagy, Roel L.G. & Fleten, Stein-Erik & Sendstad, Lars H., 2023. "Don’t stop me now: Incremental capacity growth under subsidy termination risk," Energy Policy, Elsevier, vol. 172(C).
    10. Hickey, Conor & Deane, Paul & McInerney, Celine & Ó Gallachóir, Brian, 2019. "Is there a future for the gas network in a low carbon energy system?," Energy Policy, Elsevier, vol. 126(C), pages 480-493.
    11. Guindon, A.-A. & Wright, D.J., 2020. "Analytical approach to quantitative risk assessment for solar power projects," Renewable and Sustainable Energy Reviews, Elsevier, vol. 133(C).
    12. Bunn, Derek W. & Muñoz, José I., 2016. "Supporting the externality of intermittency in policies for renewable energy," Energy Policy, Elsevier, vol. 88(C), pages 594-602.
    13. Michail Chronopoulos & Verena Hagspiel & Stein-Erik Fleten, 2016. "Stepwise Green Investment under Policy Uncertainty," The Energy Journal, , vol. 37(4), pages 87-108, October.
    14. Bunn, Derek & Yusupov, Tim, 2015. "The progressive inefficiency of replacing renewable obligation certificates with contracts-for-differences in the UK electricity market," Energy Policy, Elsevier, vol. 82(C), pages 298-309.
    15. Tietjen, Oliver & Pahle, Michael & Fuss, Sabine, 2016. "Investment risks in power generation: A comparison of fossil fuel and renewable energy dominated markets," Energy Economics, Elsevier, vol. 58(C), pages 174-185.

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