Strategic interactions along the energy transition

Abstract

With growing concerns about the impact of human activity on global warming, many countries have pledged to decarbonize their electric grids, investing heavily in intermittent renewable energy sources: solar panels and wind turbines. We highlight an overlooked feature of renewable energy — non-diversifiable supply risk — and show that an economy with no conventional installed capacity cannot avoid occasional blackouts by increasing its renewable capacity, nor through bilateral trade with similar neighbors. We develop a model of international trade in electricity with endogenous base-load capacity and heterogeneous beliefs about the covariance structure of the error term. We derive necessary conditions for symmetric and asymmetric equilibria to exist. A surprising result is that an optimistic country, i.e. one that believes the errors are less correlated, would choose a higher base-load capacity in expectation of more trade than the counterpart.