Essays on risk and profitability in the future British electricity industry

Abstract

This thesis analyses risk and profitability issues in the future British electricity industry through three different studies. The first study develops a novel and fully endogenous portfolio investment model for firms in a competitive electricity industry when they face uncertainties from fuel prices, demand levels, carbon price and renewable penetration. This study finds that both risk aversion and carbon price are crucial factors for investments in nuclear technology. The second study analyses the impact of the cost of capital on optimal investments. Two distinct costs of capital of a project are considered: one in the pre-development and construction (pre-operation) phase and the other in the operation phase. The pre-operation cost of capital is based on the complex and capital-intensive nature of a project, which prevents potential investors from undertaking them under high costs – this is the first driving force for investment followed by the operation cost of capital. Operation cost of capital is based on a company’s ability to generate cash flows that cover debt requirements by varying the debt-equity ratio that a firm can attain. The greater the cash-flow risk, the lower is the level of debt that the firm can include in its financing, and hence, the higher the weighted average cost of capital, given that debt generally benefits from tax shield. The third study analyses the profit risk of energy storage when it faces fuel-price risk. Specifically, it assesses the future electricity industry with different levels of renewable penetration and storage energy capacity. The study shows that energy storage profits depend on the electricity price risk when it makes profits from arbitrage and reserve provision and also shows that storage profit has a positive correlation with that of other generators, especially with profits of gas stations, and this correlation is moderated with the level of electricity demand.