Investment incentives in a wholesale electricity market with storage

Abstract

This paper explores the role of markets in facilitating the transition to renewable energy sources. It investigates the effectiveness of a wholesale market design in which all electricity is traded on the spot market to provide price signals that encourage investments in renewable generation and storage during this transition. To do this, we develop a model that represents a two-period electricity sector, distinguishing between daytime and nighttime, where a fossil fuel generator competes with a renewable (solar) generator that has zero marginal cost during the daytime. In the absence of storage, we analyze the impact of price caps and competition on incentivizing investments in renewable generation. We then introduce the storage of electricity during the daytime to supply it during nighttime, considering both an independent operator and an integrated renewable generation-storage operator. Our key finding is that incorporating storage for renewable generators leads to larger initial investments in renewable generation and substitution of fossil fuel generation by (stored) renewable generation at nighttime. We also show that achieving second-best outcomes requires competition to work, and in its absence, appropriately chosen price caps are required. This paper identifies the need for both minimum prices for limiting the exercise of market power when demand is low and maximum prices for limiting exercise of market power when demand is high.