Risk aversion and flexibility options in electricity markets

Abstract

Flexibility options, such as demand response, energy storage and interconnection, have the potential to reduce variation in electricity prices between different future scenarios, thereby reducing investment risk. Investing in flexibility options can also lower the need for generation capacity. However, there are complex interactions between different flexibility options. In this paper, we investigate the interactions between flexibility and investment risk in electricity markets. In particular, we focus on the investment strategies of risk-averse decision-makers. We employ a large-scale stochastic transmission and generation expansion model of the European electricity system, providing it with uncertain future scenarios based on ENTSOs’ Ten-Year Network Development Plan. Using this model, we first investigate the effect of risk aversion on investment decisions. We find that the interplay of parameters leads to (i) more investment in a less emission-intensive energy system if planners are risk averse (hedging against CO2 price uncertainty), (ii) constant total installed capacity, regardless of the level of risk aversion (i.e. planners do not hedge against demand and uncertainties when deploying renewable energy sources) and (iii) an allocation of investments that disregards cost differences for load shedding across Europe. Second, we examine the individual effects of three flexibility elements on optimal investment levels at different levels of risk aversion: demand response, investment in additional interconnection capacity and investment in additional energy storage. We show that flexible technologies have a higher value for risk-averse decision-makers, although the effects are nonlinear. Finally, we investigate the interactions between the flexibility elements. We find that risk-averse decision-makers show a strong preference for transmission-grid expansion once flexibility is available at a low cost.