Investment Opportunities, Uncertainty, and Renewables in European Electricity Markets

We investigate investment decisions in electricity generation technologies under uncertainty. The econometric analysis is based on a vast dataset of electricity generation capacities of virtually all European power plants, which we combine with disaggregated measures of investment opportunities and uncertainty. Our approach allows for a disaggregated analysis at the asset level (i.e. different electricity generation technologies) of the firm. Across technologies, we find investment to follow market incentives despite sunk and irreversible capital, confirming the implications of the Tobin's q-model. Asset-specific uncertainty hinders investment in conventional technologies, especially in peak-load assets, while industry uncertainty even triggers investment. Given that renewable power replaces peak-load generation technologies and that investment incentives decrease over time, our results indicate that there may be under-investment in the long run.