EPRG 0626

Fabien Roques, David Newbery, William Nuttall

Fuel mix diversification incentives in liberalised electricity markets: a Mean-Variance Portfolio Theory Approach

EPRG 0626 Non-Technical Summary | PDF

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Abstract: The risks and returns associated with different choices of electricity generation technology cannot properly be considered in isolation. The paper considers their impact on an investing company, using Mean-Variance Portfolio (MVP) theory to identify optimal generation portfolios in liberalised electricity markets characterised by fuel, CO2, and electricity price risk. The paper demonstrates the importance of correlations between electricity, CO2, and fuel prices, which explain the dominance of combined-cycle gas turbines. It questions whether the market can provide incentives for socially optimal fuel-mix diversification.

Keywords: fuel-mix, price risk, Mean-Variance Portfolio theory

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