How do External Costs affect Pay-as-bid Renewable Energy Connection Auctions?

Renewable energy deployment costs comprise both internal generation costs and external location-related infrastructure, environmental and social costs. To minimise generation costs, competitive connection contract auctions are becoming increasingly common. Should external costs have considerable influence on site selection outside of the auction process, optimal bidding strategies may be affected by the resulting re-ranking of winning bids. This paper elicits the impact this may have on optimal bidding behaviour. Specifically, we address the impact internalisation of external costs may have on bidding strategy. With deterministic generation costs, optimal bidding strategies include a markup. The optimal markup is lower if external costs are internalised into the investment decision. If investors have the ability to appropriate rents, due to market dominance or asymmetric information, non-internalised external costs lower markup. Generation cost uncertainty may result in below-cost bidding. This is less likely when externalities are not internalised. For markets where bids are competitively priced, this paper provides evidence to suggest that methods to minimise externalities associated with renewables deployment should be integrated with competitive pay-as-bid auctions.