Optimal contracts for renewable electricity

Sarah Parlane,Lisa Ryan

doi:10.1016/j.eneco.2020.104877

Abstract

Companies are increasingly choosing to procure their power from renewable energy sources, with their own set of potential challenges. This paper characterizes the contracts that minimize the cost of procuring a given amount of renewable energy from two risk averse, energy generators who are inherently unreliable (such as wind and solar). We contrast outcomes arising when investments are set in centralized and decentralized settings, with the absence of reliability addressed by either issuing orders in excess of what is needed or by investing in improved reliability. Our results suggest that future contracts may be geared towards a greater reliance on order inflation and lower investments in reliability as the cost of renewable energy keeps falling. The implications of these results for grid congestion and electricity spot market prices should be of interest to regulators and transmission system operators. • Renewable power procurement with bilateral contracts is growing but under-studied • We analyse optimal contracts with electricity generators from variable renewable energy sources • We compare results for centralized and decentralized power generation • Depending on the setting, bilateral contracts for both centralized and decentralized power generation may induce order inflation rather than investment in reliability • For decentralized power generation, we find that increasing order sizes trigger countervailing incentives to invest in reliability

Highlights

In recent years, growing recognition of the threat of climate change and energy security has motivated many countries to try to diminish their reliance on fossil fuels
Our results suggest that future contracts may be geared towards a greater reliance on order inflation and lower investments in reliability as the cost of renewable energy keeps falling
We argue that assuming that is not far-fetched as the cost of renewables is falling to the point where it will become cheaper than fossil fuels and nuclear power by 2020.14 A carbon price is levied on non-renewable electricity through the EU emissions trading scheme and/or green certificates or carbon taxes in some countries

Summary

Introduction

In recent years, growing recognition of the threat of climate change and energy security has motivated many countries to try to diminish their reliance on fossil fuels. The main sources of renewable electricity, after hydropower, are onshore wind and solar photovoltaic energy (REN21, 2019) These sources of energy generate variable and intermittent power that leads to uncertainty in supply and on average significantly lower utilisation rates or capacity factors than fossil fuel power plants (Pollitt and Anaya, 2016).. This paper fills a gap in the literature in applying contract theory to bilateral electricity contracts that require 100% renewable electricity, which it might be argued is an important trend and challenge for the sector over the decade It addresses this by focusing on the role of order sizes and investments in reliability in a setting where risk of completion is negatively correlated with the order size due to generators facing some form of capacity constraints.

The Model

Optimal contracts under decentralized investments

Findings

Conclusions