Capacity Payment Impact on Gas-Fired Generation Investments under Rising Renewable Feed-In -- A Real Options Analysis

33 Pages Posted: 1 May 2013 Last revised: 27 Oct 2015

See all articles by Daniel Hach

Daniel Hach

WHU - Otto Beisheim School of Management

Stefan Spinler

WHU-Otto Beisheim School of Management

Date Written: April 29, 2013

Abstract

We assess the effect of capacity payments on investments in gas-fired power plants in the presence of different degrees of renewable energy technology (RET) penetration. Low variable cost renewables increasingly make investments in gas-fired generation unprofitable. At the same time, growing feed-in from intermittent RETs amplifies fluctuations in power generation, thus entailing the need for flexible buffer capacity - currently mostly gas-fired power plants. We use a real options approach to evaluate investment decisions and timing of a single investor in gas fired power generation. We investigate the necessity and effectiveness of capacity payments. Our model incorporates multiple uncertainties and assesses the effect of capacity payments under different degrees of RET penetration. In a numerical study, we implement stochastic processes for peak-load electricity prices and natural gas prices. We find that capacity payments are an effective measure to promote new gas-fired generation projects. Especially in times of high renewable feed-in, capacity payments are required to incentivize peak-load investments.

Keywords: Capacity mechanism, capacity market, peak-load electricity generation, investment incentives, renewable energy, real options

JEL Classification: Q48, L94, L98, C44, D81

Suggested Citation

Hach, Daniel and Spinler, Stefan, Capacity Payment Impact on Gas-Fired Generation Investments under Rising Renewable Feed-In -- A Real Options Analysis (April 29, 2013). Available at SSRN: https://ssrn.com/abstract=2258386 or http://dx.doi.org/10.2139/ssrn.2258386

Daniel Hach (Contact Author)

WHU - Otto Beisheim School of Management ( email )

Burgplatz 2
Vallendar, 56179
Germany

Stefan Spinler

WHU-Otto Beisheim School of Management ( email )

Burgplatz 2
Vallendar, 56179
Germany
+49-261-6509430 (Phone)

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