Optimal contracts for renewable electricity
Companies are increasingly choosing to procure their power from renewable energy sources, with their own set of potential challenges. This paper characterizes the contracts that minimize the cost of procuring a given amount of renewable energy from two risk averse, energy generators who are inherently unreliable (such as wind and solar). We contrast outcomes arising when investments are set in centralized and decentralized settings, with the absence of reliability addressed by either issuing orders in excess of what is needed or by investing in improved reliability. Our results suggest that future contracts may be geared towards a greater reliance on order inflation and lower investments in reliability as the cost of renewable energy keeps falling. The implications of these results for grid congestion and electricity spot market prices should be of interest to regulators and transmission system operators. • Renewable power procurement with bilateral contracts is growing but under-studied • We analyse optimal contracts with electricity generators from variable renewable energy sources • We compare results for centralized and decentralized power generation • Depending on the setting, bilateral contracts for both centralized and decentralized power generation may induce order inflation rather than investment in reliability • For decentralized power generation, we find that increasing order sizes trigger countervailing incentives to invest in reliability