Investments in Renewable and Conventional Energy: The Role of Operational Flexibility

There is an ongoing debate among energy experts on how providing a subsidy for one energy source affects the investment in other sources. To explore this issue, we study capacity investments of a utility firm in renewable and conventional sources. Specifically, conventional sources are categorized into two groups as inflexible (e.g., nuclear and coal-fired plants) and flexible (e.g., natural gas), based on operational flexibility, i.e., whether or not the output of a source can be ramped up or down quickly. We model this problem as a two-stage stochastic program in which the firm first determines the capacity investment levels, followed by the dispatch quantities of energy sources so as to minimize the sum of the investment and generation-related costs. We derive the optimal capacity portfolio and characterize the interactions between renewable and conventional sources. We find that operational flexibility plays a key role in these interactions: renewable and inflexible sources are substitutes, whereas renewable and flexible sources are complements. This result suggests that a subsidy for the nuclear or coal-fired power plants leads to a lower investment level in renewables, whereas a subsidy for the natural gas-fired power plants leads to a higher investment in renewables. We validate this insight by using real electricity generation and demand data from the state of Texas. Finally, we show that a carbon tax leads to a lower renewable investment if the inflexible source is carbon-free nuclear energy.