Tuesday, June 5, 2012

Strategic Investment in Renewable Energy Sources
INSEAD Working Paper 2012/59/TOM revised version of 2011/05/DS/TOM

We analyze incentives for investing in renewable electricity generating capacity by modeling the trade-o between renewable (e.g. wind) and nonrenewable (e.g. natural gas) technology. Renewable technology has higher investment cost and yields only an intermittent supply of electricity; nonrenewable technology is reliable and has lower investment cost but entails both fuel expenditures and carbon emission costs. With reference to existing electricity markets, we model several interrelated contexts|the vertically integrated electricity supplier, market competition, and partial market competition with long-term xed-price contracts for renewable electricity|and examine the e ect of carbon taxes on the cost and share of wind capacity in an energy portfolio. We nd that the intermittency of renewable technologies drives the e ectiveness of carbon pricing mechanisms, which suggests that increasing emissions prices could unexpectedly discourage investment in renewables. We also show that market liberalization may have a negative e ect on investment in renewable capacity while increasing the overall system's cost and emissions. Fixed-price contracts with renewable generators can mitigate these detrimental e ects, but not without possibly creating other problems. Actions to reduce the intermittency of renewable sources may be more e ective than carbon taxes alone at promoting investment in renewable generation capacity.