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Optimal contracts for renewable electricity

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  • Parlane, Sarah
  • Ryan, Lisa
Abstract
Companies are increasingly choosing to procure their power from renewable energy sources, with their own set of potential challenges. This paper characterizes the contracts that minimize the cost of procuring a given amount of renewable energy from two risk averse, energy generators who are inherently unreliable (such as wind and solar). We contrast outcomes arising when investments are set in centralized and decentralized settings, with the absence of reliability addressed by either issuing orders in excess of what is needed or by investing in improved reliability. Our results suggest that future contracts may be geared towards a greater reliance on order inflation and lower investments in reliability as the cost of renewable energy keeps falling. The implications of these results for grid congestion and electricity spot market prices should be of interest to regulators and transmission system operators.

Suggested Citation

  • Parlane, Sarah & Ryan, Lisa, 2020. "Optimal contracts for renewable electricity," Energy Economics, Elsevier, vol. 91(C).
    • Handle: RePEc:eee:eneeco:v:91:y:2020:i:c:s0140988320302176
    DOI: 10.1016/j.eneco.2020.104877
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    More about this item

    Keywords

    Renewable electricity contracts; Power purchase agreements; Newsvendor model; Risk aversion; Order inflation; Moral hazard;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation
    • L24 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Contracting Out; Joint Ventures
    • L94 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Electric Utilities
    • Q21 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Renewable Resources and Conservation - - - Demand and Supply; Prices

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