More or Less? How Long-Term Demand Forecasts Shape Optimal Decarbonization Paths

Abstract

Many countries have committed to rapid investment in renewable power generation capacity to meet net-zero goals. The path to meet these carbon targets, however, is challenging to plan due to uncertainty inherent in long-term forecasts for power demand, expected to quickly grow due to the decarbonization of the economy. We analytically investigate the impact of this uncertainty on optimal investments in renewable (and non-renewable) generation to meet carbon targets over time. Methodology/results: We develop two stochastic optimization problems for a regulator deciding optimal investments in zero-carbon renewable technologies and carbon-intensive non-renewable technologies under uncertain long-term demand. We first consider a problem with a single future demand period, where the regulator must meet both demand and a carbon target at least cost, employing backup short-term options (such as extending the lifetime of legacy capacity) to meet potential excess demand. We then extend this model to a dynamic setting with two demand periods to consider decarbonization paths over time. For both models, we characterize the optimal expansion decisions analytically, demonstrating that optimal investments follow newsvendor-like structures with multiple critical fractiles. In the single-period model, we find that uncertainty in long-term demand forecasts plays a critical role in optimal investments, and higher uncertainty may either increase or decrease renewable investment. In the dynamic setting we show that optimal investments exhibit discontinuities, with the regulator either investing in substantial renewable capacity early, or completely delaying it. Managerial implications: Our findings demonstrate the importance of accounting for long-term demand uncertainty in planning decarbonization paths for power generation investment, together with investment costs. Increasing demand uncertainty has a similar impact as a stricter carbon target, leading to a higher expected cost; and small changes in costs may result in different optimal planning strategies in whether to invest early in renewables or delay investment.

Keywords: sustainable operations, capacity expansion, carbon targets, renewable energy, net zero