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Managing investor and consumer exposure to electricity market price risks through Feed-in Tariff design

Devine, Mel and Farrell, Niall and Lee, William (2014): Managing investor and consumer exposure to electricity market price risks through Feed-in Tariff design.

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Feed-in Tariffs (FiTs) incentivise the deployment of renewable energy technologies by subsidising remuneration and transferring market price risk from investors, through policymakers, to a counterparty. This counterparty is often the electricity consumer. Different FiT structures exist, with each transferring market price risk to varying degrees. Explicit consideration of policymaker/consumer risk burden has not been incorporated in FiT analyses to date. Using Stackelberg game theory and option pricing, we define FiT policies that efficiently divide market price risk, conditional on risk preferences and market conditions. We find that commonly employed flat-rate FiTs are optimal when policymaker risk aversion is extremely low whilst constant premium policies are optimal when investor risk aversion is extremely low. This suggests that if investors are considerably risk averse, the additional remuneration offered to incentivise deployment under a constant premium regime may be sub-optimal. Similarly, flat-rate FiTs are sub-optimal if policymakers are considerably risk averse. When both policymakers and investors are considerably risk averse, an intermediate division of risk is optimal. We find that investor preferences are more influential than those of the policymaker when degrees of risk aversion are of a similar magnitude. Efficient division of risk is of increasing importance as renewables comprise a greater share of total electricity cost. Different divisions of market price risk may thus be optimal at different stages of renewables deployment. Flexibility in FiT legislation may be required to accommodate this

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