When the Wind of Change Blows, Build Batteries? Optimal Renewable Generation and Energy Storage Investments

Christian Kaps, Operations, Information, and Decisions, The Wharton School; Simone Marinesi, Operations, Information, and Decisions, The Wharton School; and Serguei Netessine, Operations, Information, and Decisions, The Wharton School

Abstract: Renewables have become the cheapest energy sources in most of the world but their generation remains variable and difficult to predict. However, recent technology advances have rendered large-scale electricity storage economically viable, thus mitigating the renewable intermittency issue and enabling combinations of e.g. wind and batteries to replace fossil fuel power plants. Yet, it is not well understood what the optimal capacity combination of these new technologies is. We study this by developing a two-product newsvendor model of a utility’s strategic capacity investment in renewable generation and storage to match demand while using fossil-fuel backup in case of shortages. Although today’s storage investments are mostly lithium-ion batteries, we find that for longer duration storage, capacity decisions are driven more by per-unit-cost than efficiency thus favoring less expensive, less efficient technologies such as thermal. We determine the existence of an adoption threshold beyond which investment into storage increases sharply. Furthermore, we prove renewables and storage to be complements and establish optimal capacity guidelines based on market and technology parameters. Yet, based on real-life data from Europe and the U.S., we show that in settings with two separate investors in renewable generation and storage, the latter will typically be under-invested in as the market under-values the replacement of conventional generation through marginally free renewables. Lastly, if pollution externalities were priced-in, multi-GWh storage would become optimal in all studied markets.

Read the full working paper here (PDF).