Risk aversion and flexibility options in electricity markets

Abstract

Flexibility options, such as demand response, energy storage and interconnection, have the potential to reduce variation in electricity prices between different future scenarios, therefore reducing investment risk. Moreover, investment in flexibility options can lower the need for generation capacity. However, there are complex interactions between different flexibility options. In this paper, we investigate the interactions between flexibility and investment risk in electricity markets. In particular, we focus on investment strategies of risk-averse decision-makers. We employ a large-scale stochastic transmission and generation expansion model of the European electricity system. Using this model, we first investigate the effect of risk aversion on the investment decisions. We find that the interplay of parameters leads to (i) more investment in a less emission-intensive energy system if planners are risk averse (hedging against CO₂ price uncertainty), (ii) constant total installed capacity, regardless of the level of risk aversion (planners do not hedge against demand and RES deployment uncertainties). Second, we examine the individual effects of three flexibility elements on optimal investment levels under different levels of risk aversion, i.e., demand response, investment in additional interconnection capacity and investment in additional energy storage. We show that flexible technologies have a higher value for risk-averse decision-makers, although the effects are nonlinear. Finally, we investigate the interactions between the flexibility elements. We find that risk-averse decision-makers show a strong preference for transmission grid expansion once flexibility is available at low cost levels.