Optimal Investment Strategy in Renewable Energy Technologies

Abstract

This paper analyzes the energy manager's investment decision in renewable energy technologies in the presence of uncertain production volumes. In this model, we assume the energy manager to be a price taker who aims at minimizing the cost to cover the firm's electricity demand, by deciding upon the optimal level of investment in renewable self-generation facilities. We show, that the "reliability-based planning paradigm'', where threshold on the demand coverage probability is imposed, leads to suboptimal renewable energy portfolios compared to the "balancing-cost-based planning paradigm'', where the price of demand coverage violations is exogeneously fixed. We analyze the energy manager's optimal investment decision in renewables in the balancing-cost-based approach for two different types of the outside option, i.e., purchasing residual power (i) via pre-contracted energy at a fixed price or (ii) at the balancing market with a stochastic energy price. We find that the energy manager is reluctant to invest in renewable energy technologies, when the price of pre-contracted energy is below a critical threshold price, which itself decreases with decreasing prices of the investment goods. Moreover, the energy manager increases investment in renewables with increasing spot price volatility in order to hedge against spot price risk. In the presence of negative correlations between the power output and spot price, i.e. whenever there is a shortfall in the power supply energy prices tend to be higher, the energy manager's optimal decision is to increase (decrease) the optimal level of investment depending on weather the level of investment in the uncorrelated scenario is high (low).