Strategic Investment in Renewable Energy Sources: The Effect of Supply Intermittency

To analyze incentives for investing in the capacity to generate renewable electricity, we model the trade‐off between renewable (e.g., wind) and nonrenewable (e.g., natural gas) technology. Renewable technology has a higher investment cost and yields only an intermittent supply of electricity; nonrenewable technology is reliable and has lower investment cost but entails both fuel expenditures and carbon emission costs. With reference to existing electricity markets, we model several interrelated contexts–the vertically integrated electricity supplier, market competition, and partial market competition with long‐term fixed‐price contracts for renewable electricity–and examine the effect of carbon taxes on the cost and share of wind capacity in an energy portfolio. We find that the intermittency of renewable technologies drives the effectiveness of carbon pricing mechanisms, which suggests that charging more for emissions could unexpectedly discourage investment in renewables. We also show that market liberalization may reduce investment in renewable capacity while increasing the overall system’s cost and emissions. Fixed‐price contracts with renewable generators can mitigate these detrimental effects, but not without possibly creating other problems. In short, actions to reduce the intermittency of renewable sources may be more effective than carbon taxes alone at promoting investment in renewable generation capacity. The online appendix is available at https://doi.org/10.1287/msom.2017.0621.