Risk aversion and technology mix in an electricity market

- We consider the effect of risk aversion on the choices of capacities by electricity producers.
- The technological mix can be modified in two ways.
- Risk aversion can imply an increase in the investment in the risky technology and in total capacity.
- The effects of the cost structure and the variability of demand are investigated.

This article analyzes the effect of risk and risk-aversion on the long-term equilibrium technology mix in an electricity market. It develops a model where firms can invest in baseload plants with a fixed variable cost and peak plants with a random variable cost, and demand for electricity varies over time but is perfectly predictable. At equilibrium the electricity price is partly determined by the random variable cost and the returns from the two kinds of plants are negatively correlated. When the variable cost of the peak technology is high the return of peak plants is low but the return to baseload plants is high. Risk-averse firms reduce the capacity of the riskiest technology and develop the capacity of the other, compared to risk-neutral firms. In the particular case where a risk-neutral firm invests heavily in baseload technology and only sparely in peak capacity, a risk-averse firm would invest less in baseload, increase peak capacity, and increase total installed capacity.