W3.2 Economics of Generation Investment

Key points

• Build vs run: building compares $AC = \frac{C_f}{h} + C_v$ at expected hours; running compares VC only (fixed cost sunk)
• Break-even hours split demand. E.g. base (low $C_v$, coal), mid (CCGT), peak (low $C_f$, OCGT)
• Energy-only market: scarcity price spikes pay for capacity; optimum at LRMC = VoLL → security of supply < 100%
• Price cap too low → missing money → under-investment → capacity mechanisms
• Also: regulatory and other uncertainty, risk aversion (risk asymmetry), investment cycles, reserve capacity as a public good
• Existing fossil plants’ sunk capital raises the CO2 price needed for new renewables

Concepts

• Plant Economics
• Investment Cost Recovery
• Merit Order
• Sunk Cost
• Public Goods
• Market Power
• Capacity Mechanisms