Industry evolution, rational agents and the transition to sustainable electricity production

Guiding a transition to low carbon electricity requires a good understanding of the substitution of old by new technologies in the electricity industry. With the aim of explaining historical change from coal to gas in the British electricity industry, we develop a formal model of technological change, where energy technologies diffuse through the construction of new power plants. We considered two model versions: with rational and boundedly rational investors. In each model version, we look at the causal relations between price and output setting mechanisms, fuel and labour use, and investment decisions for different institutional arrangements. We quantify model parameters on data for the United Kingdom. We find that the version of the model with rational investors is capable of replicating well core features of UK electricity history. This includes a rapid diffusion of gas in electricity production, the evolution of the average size of newly installed plants, and a high percentage of electricity sales covered by (forward) contracts-for-difference. In this model setting, nuclear and renewable energies have no chance to diffuse on the market. In the version of the model with boundedly rational investors, nuclear power typically dominates electricity production. We discuss implications of our modelling results for making a transition to low carbon electricity in the future. - Highlights: → We propose a model of a transition from coal to gas in electricity production. → Energy technologies diffuse through the construction of new power plants. → We considered two model versions: with rational and boundedly rational investors. → We quantify model parameters on data for the UK for the period 1990-2002. → We draw policy conclusions for guiding a transition to low carbon electricity.