Working Paper: CEPR ID: DP12556
Authors: Gerard Llobet; Atilano Jorge Padilla
Abstract: This paper examines the optimal capacity choices of conventional power generators after the introduction of renewable production. We start with a basic andgenerally accepted model of the liberalized wholesale electricity market in which firms have insufficient incentives to invest and we illustrate how the entry of renewable generation tends to aggravate that problem. We show that the incentives to invest in firm capacity (e.g. conventional thermal plants) may be restored by means of a capacity auction mechanism. That mechanism is vulnerable and, hence, may prove ineffective unless governments can credibly commit not to sponsor the entry of new capacity outside the auction mechanism. We explain that such commitment may be particularly difficult in the current political context where energy policy is conditioned by environmental and industrial-policy goals. We finally propose a way to enhance the credibility of capacity auctions by committing to optimally retire idle (conventional) power plants in response to entry outside the auction.
Keywords: conventional generation; renewable energy; security of supply; missing money problem; environmental goals; capacity payments
JEL Codes: L51; L94
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Renewable energy entry (Q42) | Conventional power plant investment incentives (L94) |
| Renewable energy entry (Q42) | Average and peak wholesale electricity prices (L97) |
| Average and peak wholesale electricity prices (L97) | Utilization of conventional plants (L94) |
| Utilization of conventional plants (L94) | Profitability of conventional plants (L94) |
| Capacity auctions (L90) | Investment incentives for conventional plants (L94) |
| Government commitment (H11) | Effectiveness of capacity auctions (D44) |
| Exogenous increases in renewable capacity (Q42) | Credibility of capacity mechanisms (L97) |
| Commitment to retire idle conventional power plants (L94) | Credibility of capacity auctions (D44) |
| Renewable energy entry (Q42) | Long-term decline in conventional capacity (D25) |