Renewables, Allowances Markets, and Capacity Expansion in Energy-Only Markets

We investigate the combined effect of an Emission Trading System (ETS) and renewable energy sources on electricity generation investment in energy-only markets. We propose a simple representation of the capacity expansion decision between fossil fuel and renewable production, where electricity demand is uncertain. Increasing renewable capacity creates a tradeoff for large electricity producers: a higher share of renewable production can be priced at the higher marginal cost of fossil fuel production, yet the likelihood of achieving higher profits is reduced because more demand is met by cheaper renewable production. A numerical application of the model shows that producers prefer withholding investments in renewable energy sources, calling into question the long-term efficacy of an ETS in achieving decarbonisation goals.