Diversity and ignorance in electricity supply investment: Addressing the solution rather than the problem

Abstract

The need for diversity has been cited as a rationale for important recent investment decisions in the UK electricity supply sector. It is invoked as the principal argument for continuing major government intervention. Yet there exists no formal analytical basis for the concept. Why is diversity good? What is meant by ‘diversification’? What is it that must be ‘diversified’? What trade off should be struck between ‘diversity’ and other measures of performance? The resulting ambiguity causes confusion and is vulnerable to special pleading. Despite this, this paper argues that diversification offers a superior alternative to probabilistic approaches towards uncertainty and ignorance in electricity supply investments and proposes a formal analytical approach. A quantitative index of diversity is borrowed from information theory and used to derive a value for the government's implicit willingness to pay for diversity in the UK electricity supply mix. This is then applied in a pilot exercise to the problem of optimizing the diversity and financial performance of the supply portfolio. Although provisional, the results are relevant to the government's forthcoming Nuclear Review, particularly in assessing the relative levels of support for nuclear power and renewable energy.