Revenue and Risk of Variable Renewable Electricity Investment: The Cannibalization Effect Under High Market Penetration

Abstract

The market revenue for variable renewable electricity (VRE) assets has been under intense scrutiny during the last few years. The observation that wind and solar power depress market prices at times when they produce the most has been termed the 'cannibalization effect', and its magnitude has been established within the economic literature on current and future markets. Although it will have a substantial impact on the revenue of VRE technologies, the cannibalization effect is neglected in the capital budgeting literature, including portfolio- and real options theory.In this paper, we present an analytical framework that explicitly models the correlation between VRE production and electricity price, based on the production costs of surrounding generation capacity. We derive closed-form expressions for the short-term and long-term expected revenue, the variance of the revenue and the timing of investments.The effect of including these system characteristics is illustrated with numerical examples, where we find the cannibalization effect to decrease projected profit relative to investment cost from $33$\% to between 13% and -40%, depending on the assumption for the future VRE capacity expansion rate. Using a real options framework, the investment threshold increases by between 13% and 67%, due to the inclusion of cannibalization.

Keywords: Variable renewable energy, Cannibalization effect, Merit order effect, Investment analysis