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Capacity payment impact on gas-fired generation investments under rising renewable feed-in — A real options analysis

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  • Hach, Daniel
  • Spinler, Stefan

Abstract

We assess the effect of capacity payments on investments in gas-fired power plants in the presence of different degrees of renewable energy technology (RET) penetration. Low variable cost renewables increasingly make investments in gas-fired generation unprofitable. At the same time, growing feed-in from intermittent RETs amplifies fluctuations in power generation, thus entailing the need for flexible buffer capacity—currently mostly gas-fired power plants. A real options approach is applied to evaluate investment decisions and timing of a single investor in gas-fired power generation. We investigate the necessity and effectiveness of capacity payments. Our model incorporates multiple uncertainties and assesses the effect of capacity payments under different degrees of RET penetration. In a numerical study, we implement stochastic processes for peak-load electricity prices and natural gas prices. We find that capacity payments are an effective measure to promote new gas-fired generation projects. Especially in times of high renewable feed-in, capacity payments are required to incentivize peak-load investments.

Suggested Citation

  • Hach, Daniel & Spinler, Stefan, 2016. "Capacity payment impact on gas-fired generation investments under rising renewable feed-in — A real options analysis," Energy Economics, Elsevier, vol. 53(C), pages 270-280.
    • Handle: RePEc:eee:eneeco:v:53:y:2016:i:c:p:270-280
    DOI: 10.1016/j.eneco.2014.04.022
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    More about this item

    Keywords

    Capacity mechanism; Capacity market; Peak-load electricity generation; Investment incentives; Renewable energy; Real options;
    All these keywords.

    JEL classification:

    • Q48 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Government Policy
    • L94 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Electric Utilities
    • L98 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Government Policy
    • C44 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Operations Research; Statistical Decision Theory
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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