Technological diversification of power generation portfolios

Technological diversity is an important objective in the energy sector, because, in addition to other benefits, it can serve as an insurance against price shocks. Many countries use instruments, such as technology-specific subsidies or R& D subsidies, to increase diversification in power conversion technologies. We use a two-stage investment model with cost and demand uncertainty to investigate whether a mean-variance approach can be used for energy market settings. In this context, this doctoral dissertation investigates four related topics. First, it inquires which economic tools can be used to study diversification in the energy sector. Many studies in this field are based on a mean-variance approach. We show that a mean-variance setup arises naturally from the microeconomic investment problem, but that adjustments are necessary to capture the ability of firms to alter their production decisions after investment as well as the transmission of cost shocks to the electricity market. Second, we analyze how carbon and electricity taxes or feed-in tariffs (FIT) influence firms’ technology choices and to what extent this influence depends on market power. We show that regulation instruments can significantly modify cost structures and change the respective profitability rankings of technologies. This alters the strategic behavior of the dominant market player and therewith overall investment patterns. The outcome of a policy regime is therefore not only dependent on the regulation instrument used; it is also strongly dependent on the degree of market liberalization. Third, we identify which regulatory instruments or combinations of those are optimally suited to promote electricity production using renewable energy sources in Switzerland. Besides a FIT system, certifications with the label naturemade as well as a quota model are considered. Because the outcome of a policy regime is dependent on the level of competitiveness in the market, an ongoing market liberalization interacts with policy regulation. In view of how detached discussions on energy policy are from considerations of market liberalization, we demonstrate how essential it is that both issues be investigated jointly. Finally, we investigate to what extent existing investments constrain market power and alter the incentives set by energy and climate policy. Our results suggest that the dependency of current decisions on past investments can significantly interact with market power. Already installed power generation capacities hinder the exercise of market power and the influence of the dominant firm in the production stage, but they raise the incentive of the dominant market player to strategically use the regulation instrument in place.