Capacity Market and Investments in Power Generations: Risk-Averse Decision-Making of Power Producer

The penetration of power generations from renewable energy sources into the power market has a significant impact on the capacity factor of existing power generations. This is because power producers cannot recover a capital cost of power generations with high operating cost possibly due to underinvestment. One solution to address this problem includes a capacity mechanism; that is, the capacities of the power generations can be sold through a market or a bilateral contract. Many schemes of the capacity mechanism have been used worldwide. In this study, we examine an investment in a power plant in both the electricity and capacity markets. The effect of investment opportunity on uncertainty and risk aversion is analyzed by a real options approach that is one of analytical methods for investment decisions under uncertainty. The investment timing for the standard energy-only market is compared with that for the capacity market. When the risk averse for the power producer is relatively small, the income in the energy-only market is obtained whereas, when the risk averse is relatively high, the income is gained in both the electricity and capacity markets for the sake of enough profit.

Automated summary

The penetration of renewable energy sources into the power market has a significant impact on existing power generations. Power producers are facing challenges in recovering capital costs due to high operating costs and underinvestment. One solution is the implementation of a capacity mechanism, where power generation capacities can be sold through a market or bilateral contracts. This study examines investment in a power plant in both the electricity and capacity markets, analyzing the effects of investment opportunities, uncertainty, and risk aversion. The results show that the investment timing differs between the energy-only market and the capacity market, depending on the level of risk aversion.