Strategic Investment in Renewable Energy Sources

In this paper we analyze incentives for investment in renewable electricity generating capacity. In particular, we model the tradeoff between investing in a renewable technology (such as wind) and a non-renewable technology (such as natural gas). The renewable technology has higher investment cost and is intermittent-that is, the supply of electricity from this technology is uncertain. The non-renewable technology is reliable and has a lower investment cost, but generation of electricity from this technology entails fuel expenditures as well as emission (carbon) costs. Motivated by existing electricity markets, we model several interrelated contexts, including: (a) vertically integrated electricity supplier, (b) market competition and (c) partial market competition with long-term fixed-price contracts for renewable electricity. Within these contexts we examine the impact of carbon taxes on the total cost and the share of wind capacity in the total capacity portfolio. We nd that intermittency is the critical aspect of renewable technologies which drives the effectiveness of carbon pricing mechanisms. Our results suggest that, due to intermittency of supply and the need for backup generating capacity, increasing the price of carbon emissions may have an unexpected adverse effect on investment in renewables. In addition, we show that market liberalization can have a negative effect on investment in renewable capacity, total cost and total emissions of the system. Fixed price contracts with renewable generators can mitigate these detrimental effects, but they may also lead to excess renewable capacity and insufficient non-renewable capacity in view of their complementary role as backup generators. We conclude that actions towards reducing the intermittency of the renewable energy sources (e.g., through capacity pooling or unit-specific buffering) may be more effective in promoting investment in renewable generation capacity than reliance on carbon taxes alone.