Wind Capacity Investments : Inefficient Drivers and Long-Term Impacts

There is substantial concern that high variability of wind energy production on the electricity grid can increase outage risks, reliability costs, and energy market price fluctuations. Ian Schneider and Mardavij Roozbehani of the Massachusetts Institute of Technology explain how existing production-based subsidies for wind energy bias marginal investments to underweight the market value of energy produced, which leads to higher production correlation between developed wind sites and therefore increases system wide variability of wind energy production. A pure energy-only market has been shown, under certain conditions, to create optimal incentives for market entry. This research extends these results to the case of potential entrants with variable and non-controllable production, such as wind generators. It also examines the effects of subsidies on these incentives for market entry and investment. Two important criteria for investment in wind capacity are the total energy production and the average market value for energy produced at the wind site under consideration. The tradeoff between these values is important because high-production sites are frequently located near previous wind development, which suppresses local prices and thus the expected energy market value of future production. Production based subsidies for wind energy, like the federal Production Tax Credit (PTC) and many state Renewable Portfolio Standard (RPS) credits or subsidies, bias investment at the margin towards sites with higher expected capacity values, i.e. with higher total production per unit of site capacity, but with less concern for the correlation between energy output and market prices. This research explains explain how this tradeoff is derived from the optimization problem of a profit-maximizing wind investor, and they derive the impact of the PTC and other energy market policies on the efficient frontier of optimal investments. Furthermore, since wind production depresses prices, this bias is linked to covariance between wind sites. Fixed-price support mechanisms like the PTC lead to market equilibriums with higher levels of wind correlation, which can increase system costs for capacity and grid stability. This research is based on previous work that was published by Ian Schneider and Mardavij Roozbehani as a working paper by the MIT Center for Energy and Environmental Policy Research. It aims to add additional insight by measuring the effect of these subsidies in real-world systems. With new results, we aim to clarify which subsidy mechanisms can be expected to inefficiently bias long-term subsidies. We also focus on extensions with special relevance to the European context. In particular, feed-in tariffs represent a particular edge case, whereby potential investors no longer have any incentive to consider the correlation between planned new generation and existing generation. While volumetric based subsidies that are used in conjunction with wholesale offers for electricity might be seen as more efficient, this paper suggests lingering downsides to that approach. Finally, this research proposes more efficient methods for subsidizing renewable energy generation. It compares these methods to approaches that focus on carbon regulation (e.g. carbon taxes and cap-and-trade) and explains when they might be efficiently used alongside one another.