Elsevier

Energy Economics

Volume 102, October 2021, 105470
Energy Economics

Measuring the effects of environmental policies on electricity markets risk

https://doi.org/10.1016/j.eneco.2021.105470Get rights and content

Highlights

  • We study effects of environmental policies on cost/risk in the generation sector.

  • We compute long-term equilibria in a complete market and use as benchmark.

  • We compare these with equilibria for risk-neutral firms and environmental policies.

  • RPS and carbon taxes can limit system risk exposure in a cost-efficient manner.

  • Under hydro availability and fossil fuel price risks, RPS delivers better outcomes.

Abstract

This paper studies how environmental policies, such as renewable portfolio standards (RPS) and carbon taxes, might contribute to reducing risk exposure in the electricity generation sector. We illustrate this effect by first computing long-term market equilibria of the Chilean generation sector for the year 2035 using a risk-averse planning model, considering uncertainty of hydrological scenarios and fossil fuel prices as well as distinct levels of risk aversion, but assuming no environmental policies in place. We then compare these risk-averse equilibria to generation portfolios obtained by imposing several levels of RPS and carbon taxes in a market with risk-neutral firms, separately. Our results show that the implementation of both policies can provide incentives for investments in portfolios of generation technologies that limit the risk exposure of the system, particularly when high levels of RPS (35%) or high carbon taxes (35 $/tonCO2) are applied. However, we find that in the case of a hydrothermal system, the resulting market equilibria under RPS policies yield expected generation cost and risk levels (i.e. standard deviation of costs) that are more similar to the efficient portfolios determined using a risk-averse planning model than the ones we find under the carbon tax.

Introduction

A growing number of studies have proposed that renewable energy sources1 (RES), such as solar photovoltaic (PV) and wind farms, can contribute to strengthen a country's energy security and resilience due to their independency from volatile international fuel prices, hydrological variability and other types of risks. Since the seminal work of Shimon Awerbuch (Awerbuch, 2006; Awerbuch and Berger, 2003) frameworks and mathematical tools (i.e., risk-averse planning models) capable of determining generation portfolios that are robust to risk have been developed and utilized to analyze several countries' energy mixes considering both expected cost and risk. Moreover, a number of these works have consistently concluded that when renewable energy technologies are selectively added to the generating mix, it is possible to reduce the likelihood that an electric power system will face scenarios of high system costs (Calvo-silvosa et al., 2017).

Furthermore, environmental policies such as carbon taxes, cap-and-trade schemes, renewable portfolio standards (RPS), etc., have been widely established by regulators to incentivize investments in renewables. These policies are normally justified based on benefits regarding global and local pollutants emission reductions, job creation and increased energy security. In effect, regarding energy security and according to the aforementioned studies, increased investment on renewables stemming from these policies may provide benefits on electricity cost risk reduction and energy source diversification. However, this aspect has been scarcely addressed in the literature.

Hence, in this work we contribute to the existing literature by studying in detail risk reduction and diversification incentives provided by two of these environmental policies (i.e. renewable portfolio standards and carbon taxes). We achieve this by calculating several long-term market equilibria of the Chilean generation sector for the year 2035, considering distinct levels of risk aversion of market agents and uncertainty in both hydrological scenarios and fossil fuel prices. These risk-averse equilibria are then compared to generation portfolios obtained by imposing several levels of RPS and carbon taxes in a market with risk-neutral agents, separately.

Through these analyses we conclude that increased levels of either RPS or carbon taxes may reduce risk exposure of generation markets, albeit not always, due to the presence of non-monotonic relations between environmental policies and risk exposure in cases with relatively low levels of RPS or carbon tax (under 35% and 35 $/tonCO2 respectively).

Moreover, we carefully study relations between environmental policies and expected cost-risk, demonstrating that RPS policies exhibit certain advantages over carbon taxes in markets where hydro availability risk is relevant, as in Chile, since the latter may result in higher hydro reservoir investment and thus increase risk exposure of portfolios when facing hydrological risk. Alternatively, in cases where fuel price uncertainty is the main driver of risk, we find that under low levels of both RPS and carbon taxes, increased generation by thermal power plants (e.g. LNG plants) that act as a back-up for intermittent renewables such as solar PV, might produce an increase in the generating portfolios risk exposure. However, under higher levels of these policies (above the 35% and 35 ton/CO2 thresholds), we find a monotonic relationship between the level of the policy and risk reduction in all studied cases.

The present paper is organized as follows. Section 2 summarizes relevant literature regarding methodological advances in risk-averse models, the usage of these models to study several countries' generating portfolios and works that explore the impact of environmental policies in energy security. Section 3 presents the methodological aspects relevant to the present work and Section 4 details cases results and discussion. Finally, Section 5 shows the concluding remarks and policy implications of our study.

Section snippets

Study of electricity generation costs and risks under a portfolio optimization lens

The interaction between the level of penetration of renewable generation technologies and risk exposure of an electric power system was first studied by Shimon Awerbuch (Awerbuch, 2006; Awerbuch and Berger, 2003). Borrowing ideas from Harry Markowitz’ portfolio theory (Markowitz, 1952), this seminal work proposed a framework where generation technologies are characterized by the reciprocal of their levelized cost of electricity in kWh/US-cent (or “returns”), which is used to select efficient

Finding equilibrium investments with risk-neutral and risk-averse agents

A well-known result from microeconomic theory is that, under perfect competition, a competitive equilibrium can be computed by solving an equivalent Integrated Resources Planning problem that maximizes social welfare (elastic demand) or minimizes total system cost (inelastic demand) (Samuelson, 1952; Hobbs, 1995). Furthermore, if investment decisions are made under uncertainty, investors are risk-neutral, and all agents share the same views about possible future outcomes, then central planning

Results and discussion

We divide the results and their respective analysis into two main sections. The first section presents the results and discussions regarding cases that consider 75 different scenarios of hydro conditions and fossil fuel prices. The second section presents the results obtained by only considering fossil fuel price uncertainty, via 25 scenarios, all accompanied by the H2 hydrological scenario (see Table 2).

Policy implications and conclusions

Existing research suggests that investments in a diversified portfolio of various types of renewable energy technologies can reduce the exposure of a power system to volatile fossil fuel prices and hydro availability. Indeed, according to the literature, a selective addition of renewables to poorly diversified generating portfolios might enhance energy security and economic efficiency from a risk perspective. This is particularly relevant for electric power systems that rely heavily on imported

Declaration of Competing Interest

Andrés Inzunza acknowledges being currently employed at Engie Impact, sustainability consulting branch of the Engie group. Additionally, Andrés Inzunza is a minor shareholder of the energy storage company Valhalla, based in Chile. Francisco Muñoz acknowledges being Director of Research at Generadoras de Chile AG, the views expressed in this paper are those of the author(s) and do not necessarily represent the views of Generadoras de Chile AG.

Acknowledgements

This research was supported by the Instituto Sistemas Complejos de Ingeniería ANID PIA/APOYO AFB180003, CONICYT/FONDECYT 1190228 and 1181928, CONICYT/ FONDAP/15110019 (SERC-CHILE), ANID/PIA/ACT192094 and CONICYT-Basal Project FB0008.

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