Electricity is now deeply geopolitical, yet regulatory frameworks and financial tools haven’t kept pace. Existing power system planning tools rarely account for risks, especially geopolitical ones.
The traditional “least-cost” approach in regulation is outdated unless it links costs to risks. We urgently need to rethink how we plan the entire energy sector.
Modern Portfolio Theory (MPT), first developed in 1952 to balance investment risk and reward, offers a powerful method for managing risk in electricity generation. Recent studies, including a synthesis of 30 peer-reviewed papers from 2003 to 2024, support its application in this field.
The hidden volatility in your kilowatt
Traditional planning sees generation as an engineering problem—build the cheapest plant to meet demand. This ignores risks from fuel price swings, carbon costs, and currency fluctuations.
Coal plants, for example, face more than just coal price changes. These risks are often correlated, spiking together during crises such as supply shocks or geopolitical conflicts. The current mix of internal political tensions, and the Ukraine and Middle East crises, creates a perfect storm for electricity systems.
What MPT actually reveals
Applying mean-variance optimization to electricity portfolios shows that renewables are the best hedge against global price and currency swings. System planners can calculate the most efficient mix of fuel sources based on perceived risks.
For example, when coal-fired power plants were built in the 1990s, fuel costs and plant efficiency were the main factors in deciding to use Indonesian coal. Another option would have been to use local, lower-quality coal and burn it at higher cost. This approach would increase costs but provide greater security against geopolitical upheavals.
That is why I have long pushed for renewable energy—not primarily because of climate change concerns. Wind and solar have zero fuel costs, meaning their prices do not move with global commodity prices.
This low correlation with fossil fuels benefits a diversified energy portfolio and helps manage volatility. Moreover, once these plants are built, they are no longer exposed to global price fluctuations or foreign exchange risks. To complement renewables, gas-fired power plants should also be considered.
The case against complacency
MPT has limits. Electricity markets are not financial markets—assets cannot be traded overnight, and correlations may change as renewables expand.
Historical data can also mislead in rapidly evolving markets.
Fixed-price tools like power purchase agreements (PPAs) and feed-in tariffs reduce revenue volatility but also cap potential gains, effectively trading one set of risks for another.
Ignoring correlated risks in planning means accepting exposure to geopolitical shocks rather than hedging against them.
The bottom line
Energy security and financial optimization go hand in hand. Diverse energy portfolios that combine renewables with flexible gas generation can reduce geopolitical exposure and price volatility.
The tools already exist. Planners and policymakers must apply modern portfolio theory to build resilient energy systems now.
A power industry expert with over 40 years in experience as chief executive officer in firms ranging from banking, power, and advisory services.
