Strategic investment in power generation and transmission under a feed-in premium scheme: a game theoretic real options analysis

Abstract The spread of renewable energy has been accelerated by investment in power generation and transmission systems under environmental policy support such as a feed-in premium (FIP) scheme. This study examines the decision-making of the transmission system operator (TSO) and the power generation company (GENCO), where the TSO maximizes social surplus by investing in transmission lines, and the GENCO maximizes its profit by investing in power generation facilities. Specifically, the TSO decides the investment timing, while the GENCO decides the capacity. We develop a real options model to analyze the equilibrium investment timing and capacity under uncertainties in a framework of game between TSO and GENCO. We consider several scenarios in which the GENCO invests in non-renewable energy (NRE); invests in renewable energy (RE) with FIP; and invests in RE with its installation cost reduction. Our results indicate that FIP and the installation cost reduction of RE affect the equilibrium decision in a different manner. We find that FIP tends to be more welfare-enhancing than the reduction of RE installation cost when the degree of uncertainty is larger. We also demonstrate that social surplus can be increased without FIP if the installation cost of RE is reduced sufficiently in the future.