Designing electricity generation portfolios using the mean-variance approach

Abstract

The mean-variance approach (MVA) is commonly used in the financial literature for the optimal design of financial asset portfolios. The electricity sector portfolios are also guided by similar objectives, namely maximising return and minimising risk. As such, this paper proposes two possible MVAs for the design of optimal renewable electricity production portfolios. The first approach is directed at portfolio output maximisation and the second one is directed at portfolio cost optimisation. The model was implemented on data compiled from the Portuguese electricity system collected for each quarter of an hour, for a period close to four years. Three renewable energy sources (RES) portfolios were used, namely hydropower, wind power and photovoltaic. This highlighted the resource seasonality demonstrating that hydropower output positively correlates with wind power and that photovoltaic correlates negatively with both hydro and wind power. The results show that for both models the least risky solutions are characterised by a mix of RES technologies, taking advantage of the diversification benefits. As for the highest return solutions, as expected, these are the ones associated with higher risk but the portfolio composition largely depends on the assumed costs of each technology.