A decarbonization of the energy sector calls for large new investments in renewable energy production, and several countries stimulate renewable energy production through economic instruments, such as feed-in premiums or other kinds of subsidies. When choosing the location for increased production capacity, the producer has typically limited incentives to take fully into account the investments costs of the subsequent need for increased grid capacity. This may lead to inefficient choices of location. We explore analytically the design of feed-in premiums that secure an optimal coordinated development of the entire electricity system. We show that with binding electricity transmission constraints, feed-in premiums should differ across locations. By the use of a numerical energy system model (TIMES), we investigate the potential welfare cost of a non-coordinated development of grids and wind power production capacity in the Norwegian energy system. Our result indicates that grid investment costs can be substantially higher when the location decision is based on uniform feed-in premiums compared with geographically differentiated premiums However, the difference in the sum of grid investment cost and production cost is much more modest, as location based on uniform feed-in premiums leads to capacity increase in areas with better wind conditions.
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