Energy technology investments in competitive and regulatory environments

Abstract

The goal of this paper was to develop a better understanding of how energy firms might respond to competitive pressures in the context of regulatory risk. We model how competitive pressures affect capacity investments that firms make into their portfolio of technologies. Using comparative statics, we characterize energy firms’ incentives to invest in different energy technologies under imperfect competition in outputs and prices and within different environmental regulatory regimes. We find that under Cournot competition, firms that invest in renewable technologies benefit from both strategic and spillover effects on their overall profits. Under Bertrand competition, these benefits are enjoyed only by firms that invest in conventional technologies. Our findings can provide guidance for policy makers. Notably, even relatively weak targets set by regulators are likely to spur additional investment into renewable technologies. Regardless of policy type, strategic interactions and spillover benefits drive the optimal management of energy technology R&D activities. Our results also suggest ways for regulators to exploit the inherent benefits of imperfections in competitive markets to stimulate firms’ efforts at improving on the technologies in their portfolios. Overall, our results describe how technology investment incentives are shaped by the strategic interactions between firms, market structures, and environmental policy choices.