Consequences of the missing risk market problem for power system emissions

Emil Dimanchev, Steven A. Gabriel, Lina Reichenberg and Magnus Korpås

Energy Economics, 2024, vol. 136, issue C

Abstract: Liberalized power markets are characterized by a missing market problem: a limited availability of long-term contracts leaves risk-averse investors exposed to uninsured risk. We explore how this problem affects a power system’s capacity mix and overall emissions. For this purpose, we develop a new equilibrium generation expansion model that endogenously captures investors’ risk exposure in incomplete markets. Our approach addresses the problem of multiple equilibria and, partly, the computational burden inherent to such models. We solve our model for an abstract system with gas, wind, solar, and battery storage under demand and gas price uncertainty. The results first show that, when risk markets are missing, investment risk can cause higher emissions and less clean energy investment than what would be implied by a model that omits investment risk. The impact of risk on investment depends only partly on technologies’ capital intensities and largely on how technologies interact at the systems level. We also compare system outcomes with missing long-term markets to the socially optimal case, where risk-averse investors and consumers trade risk via complete long-term markets. In the absence of long-term markets, we observe higher emissions, less investment in renewables and storage, and more investment in gas. These results suggest that long-term market mechanisms for electricity generation and storage may advance climate goals while addressing inefficiencies in current markets.

Keywords: Incomplete markets; Risk aversion; Equilibrium generation expansion; Macro-energy systems; Decarbonization; Climate policy (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:eneeco:v:136:y:2024:i:c:s0140988324003475

DOI: 10.1016/j.eneco.2024.107639

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