Investments in Renewable and Conventional Energy: The Role of Operational Flexibility

Abstract

Problem definition: There is an ongoing debate on how providing a subsidy for one energy source affects the investment level of other sources. Academic/practical relevance: To investigate this issue, we study a capacity investment problem for a utility firm that invests in renewable and conventional energy, with a consideration of two critical factors. First, conventional sources have different levels of operational flexibility—inflexible (e.g., nuclear and coal) and flexible (e.g., natural gas). Second, random renewable energy supply and electricity demand are correlated and nonstationary. Methodology: We model this problem as a two-stage stochastic program in which a utility firm first determines the capacity investment levels followed by the dispatch quantities of energy sources to minimize the sum of investment and generation-related costs. Results: We derive the optimal capacity portfolio to characterize the interactions between renewable and conventional sources. Policy implications: We find that renewable and inflexible sources are substitutes, suggesting that a subsidy for nuclear or coal-fired power plants leads to a lower investment level in wind or solar energy. However, wind energy and flexible sources are complements. Thus, a subsidy for flexible natural gas-fired power plants leads to a higher investment in wind energy. This result holds for solar energy if the subsidy for the flexible source is sufficiently high. We validate these insights by using real electricity generation and demand data from the state of Texas.