Investment in electricity capacity under fuel cost uncertainty: Dual-fuel and a mix of single-fuel technologies

Nurit GAL, Irena MILSTEIN, Asher TISHLER, Chi Keung WOO

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2 Citations (Scopus)

Abstract

We study the effect of the price and price volatility of natural gas on investment in electricity capacity in two technology scenarios: (1) dual-fuel units that use natural gas and diesel; and (2) a mix of single-fuel plants that use coal or natural gas. We develop a two-stage (capacity and operation) model and derive analytical solutions for both scenarios. Based on the observed log-normal distribution of the natural gas price, we show that optimal capacity investment increases moderately with natural gas price volatility, countering a commonly held view that fuel cost uncertainty tends to discourage capacity investment. Thus, higher volatility of the natural gas price tends to reduce the 'missing money' problem. We use Texas data to show that higher gas price volatility implies higher profits and consumer surplus in the first scenario, even when the per MWh diesel cost is much higher than the expected value of the per MWh gas cost. In the second scenario, firms invest only in gas capacity, unless the per MWh coal cost is significantly below the expected per MWh gas cost, thus explaining the popularity of gas generation. Copyright © 2018 Elsevier Ltd. All rights reserved.
Original languageEnglish
Pages (from-to)518-532
JournalEnergy Policy
Volume126
Early online dateDec 2018
DOIs
Publication statusPublished - Mar 2019

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natural gas
Natural gas
electricity
Electricity
cost
Costs
Gases
gas
diesel
coal
Coal gas
Normal distribution
price
Uncertainty
Profitability
Coal
volatility

Citation

Gal, N., Milstein, I., Tishler, A., & Woo, C. K. (2019). Investment in electricity capacity under fuel cost uncertainty: Dual-fuel and a mix of single-fuel technologies. Energy Policy, 126, 518-532. doi: 10.1016/j.enpol.2018.10.040

Keywords

  • Natural gas price volatility
  • Investment under uncertainty
  • Capacity mix
  • Dual-fuel plants
  • Electricity price behavior