Market Signals and Investment in Variable Renewables

Abstract

This paper examines theoretically how price signals affect investment in renewables. While feed-in tariffs (FIT) remunerate renewables with a constant subsidy independently from the market price, feed-in premia (FIP) support them with a subsidy on top of the electricity spot price. Under FIT, a strategic investor who also owns thermal generation favors renewables whose output is more variable, less correlated with demand and more correlated with the output of the system’s renewable feed-in, therefore increasing the variability of the system’s net demand, defined as demand net of renewable output. Consequently, this can result in an increase in the costs of integrating renewables in the system. In contrast, FIP leads to investment choices that can reduce integration costs. Furthermore, for a given set of renewable plants in a competitive market, the socially optimal investment in renewable generation capacity can be implemented by a FIP scheme where the subsidy is set at the level that leads firms to internalize the externalities of renewable energy.