Abstract
We analyze optimal regulation of the gradual investments in energy networks necessary to accommodate the energy transition. We focus on a real option problem where costs of new network technology are stochastic and not observable to the regulator. We solve for the regulatory scheme that optimally balances timely investments with rent extraction in this dynamic agency context. We then apply this methodology to a situation in which investment can be either in traditional network technology, with observable costs, or using an innovative network technology for which there is asymmetric information on costs. The optimal choice trades off the potential benefits of cheaper expansion with the costs of overcoming information frictions.
Highlights
The transition to a more environmentally friendly energy market requires large investments, by competitive energy producers, and by monopolistic firms owning and operating power and gas grids
To accommodate large amounts of small-scale renewable electricity production at consumers’ homes, system balancing functions may have to be decentralized in smart grids, that require deployment of new technologies
In this paper we demonstrate how the methodology can be expanded to deal with continuous investment models. We apply this methodology to study how optimal regulation should drive investment in a greenfield situation, where there is a choice between a traditional technology, with publicly observable costs, and an innovative technology with asymmetric information on stochastic costs
Summary
The transition to a more environmentally friendly energy market requires large investments, by competitive energy producers, and by monopolistic firms owning and operating power and gas grids. In this paper we demonstrate how the methodology can be expanded to deal with continuous investment models We apply this methodology to study how optimal regulation should drive investment in a greenfield situation, where there is a choice between a traditional technology, with publicly observable costs, and an innovative technology with asymmetric information on stochastic costs. If the regulator (who is the principal) cannot observe costs, but the network (the agent) can, we first show that still, the regulator could design a set of fees that induces the agent to follow the same, first-best real-option investment rule This is costly, though, as the agent receives information rents from its advantaged position. The agent’s participation constraint is U(Q0, C0) ≥ 0 for any C0 ∈ [CL, CH]
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