Regulation and grid expansion investment with increased penetration of renewable generation

•We analyze the effect of rising shares of renewable energy sources in the generation and transmission sector.•We develop a real options model that allows us to study the two sectors simultaneously.•We find that increasing penetration through renewables leads to investment postponement in both sectors.•We analyze the risk implications of the additional investments into clean energy sources.

The recent trend toward decarbonization led to crucial challenges for network operators and regulators in terms of network reliability and optimal grid expansion. In order to analyze the effects of rising shares of renewable energy sources on investment decisions in both, the generation and the transmission sector, the following article brings together the two sectors in a single real options framework. This allows us to derive the optimal timing of the production capacity expansion and the optimal transmission price which assures its connection. We find that an increasing penetration through renewables leads to investment postponement in both sectors, which goes along with increased systematic risk. However, we show that the negative effects on the transmission firm can be overcome by choosing an appropriate incentive system.