Designing Renewable Power Purchase Agreements: Impact on Green Energy Investment

63 Pages Posted: 20 Dec 2023

See all articles by Zuguang Gao

Zuguang Gao

University of California, Irvine - Paul Merage School of Business

Nur Sunar

University of North Carolina (UNC) at Chapel Hill - Kenan-Flagler Business School

John R. Birge

University of Chicago - Booth School of Business

Date Written: December 20, 2023

Abstract

This paper studies a long-term power purchase agreement (PPA) between a firm and a new renewable energy generator. At each time, the firm must meet an uncertain electricity demand in excess of its existing energy sources. The wholesale electricity market price evolves as a stochastic process. When the firm signs a PPA, a new renewable energy facility becomes operational, and the firm owns the facility’s output during the contract. The new facility's capacity is determined based on PPA terms. The firm dynamically decides when to start a renewable PPA and total payment to the renewable energy generator to maximize its expected total discounted benefit. We show that the firm’s optimal time-to-sign a PPA is determined by a (time-varying) threshold policy. Our analysis offers key insights to policymakers and renewable energy developers. We find that, in contrast to the common understanding, increasing investment cost for renewable technology can boost renewable energy capacity and output when renewable energy facilities are developed under a PPA. This calls for caution in implementing investment tax credit for clean technologies under PPAs. We show that total renewable energy generation can decrease with site productivity. Hence, restricting renewable facility development to the most productive sites might be counterproductive under PPAs.

Keywords: renewable energy investment, power purchase agreement, capacity investment, long-term contract, optimal stopping

Suggested Citation

Gao, Zuguang and Sunar, Nur and Birge, John R., Designing Renewable Power Purchase Agreements: Impact on Green Energy Investment (December 20, 2023). Available at SSRN: https://ssrn.com/abstract=4670536 or http://dx.doi.org/10.2139/ssrn.4670536

Zuguang Gao (Contact Author)

University of California, Irvine - Paul Merage School of Business ( email )

Paul Merage School of Business
Irvine, CA California 92697-3125
United States

Nur Sunar

University of North Carolina (UNC) at Chapel Hill - Kenan-Flagler Business School ( email )

McColl Building
Chapel Hill, NC 27599-3490
United States

John R. Birge

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

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