The Visible Hand: Ensuring Optimal Investment in Electric Power Generation

Abstract

This article formally analyzes the various corrective mechanisms that have been proposed and implemented to alleviate underinvestment in electric power generation. It yields three main analytical findings. First, physical capacity certificates markets implemented in the United States restore optimal investment if and only if they are supplemented with a “no short sale” condition, i.e., producers can not sell more certificates than they have installed capacity. Then, they raise producers’ profits beyond the imperfect competition level. Second, financial reliability options, proposed in many markets, are effective at curbing market power, although they fail to fully restore investment incentives. If “no short sale” conditions are added, both physical capacity certificates and financial reliability options are equivalent. Finally, a single market for energy and operating reserves subject to a price cap is isomorphic to a simple energy market. Standard peak-load pricing analysis applies: under-investment occurs, unless production is perfectly competitive and the cap is never binding.

Keywords

Imperfect competition Market design Investment incentives

Get full access to this article

View all access options for this article.

References

Allaz

Vila

J.-L.

(1993). “Cournot competition, futures markets and efficiency.” Journal of Economic Theory 59: 116. https://dx-doi-org.web.bisu.edu.cn/10.1006/jeth.1993.1001.

Boiteux

(1949). “La tarification des demandes en pointe: Application de la théorie de la vente au cout marginal.” Revue Générale d’Electricité 58: 321-40.

Boom

(2009). “Vertically integrated firm’s investments in electricity generating capacities.” International Journal of Industrial Economics, 27: 544-551. https://dx-doi-org.web.bisu.edu.cn/10.1016/j.ijindorg.2008.08.007.

Boom

Buehler

(2014). “Vertical structure and the risk of rent extraction.” Copenhagen Business School Working Paper 11-2006 (previous version).

Borenstein

(2005). “The long-run efficiency of real time pricing.” The Energy Journal 26(3): 93-116. https://dx-doi-org.web.bisu.edu.cn/10.5547/ISSN0195-6574-EJ-Vol26-No3-5.

Borenstein

Holland

(2005). “On the efficiency of competitive electricity markets with time-invariant retail prices.” RAND Journal of Economics 36: 469-493.

Bushnell

Mansur

Saravia

(2008). “Vertical arrangements, market structure and competition.” American Economic Review 98(1): 237-266. https://dx-doi-org.web.bisu.edu.cn/10.1257/aer.98.L237.

Chao

Wilson

(1987). “Priority service: Pricing, investment, and market organization.” American Economic Review 77: 899-916.

Chao

Wilson

(2005). “Resource adequacy and market power mitigation via option contracts.” Technical Report 1010712, Electric Power Research Institute. http://stoft.com/metaPage/lib/Chao-Wilson-2003-04-resourceadequacy-op-tions.pdf.

10.

Cramton

Lien

(2000). “Value of lost load.” Mimeo, University of Maryland.

11.

Cramton

Ockenfels

(2011). “Economics and design of capacity markets for the power sector.” Mimeo, University of Maryland. http://www.cramton.umd.edu/papers2010-2014/cramton-ockenfels-economicsand-design-of-capacity-mar-kets.pdf.

12.

Cramton

Stoft

(2006). “The convergence of market designs for adequate generation capacity.” White Paper for the California Electricity Oversight Board.

13.

Cramton

Stoft

(2008). “Forward reliability markets: Less risk, less market power, more efficiency.” Utilities Policy 16(3): 194-201. https://dx-doi-org.web.bisu.edu.cn/10.1016/j.jup.2008.01.007.

14.

Crew

Kleindorfer

(1976). “Peak load pricing with a diverse technology.” The Bell Journal of Economics 7(1): 207-231. https://dx-doi-org.web.bisu.edu.cn/10.2307/3003197.

15.

Fabra

der Fehr

N.-H. V.

de Frutos

M.-A.

(2011). “Market design and investment incentives.” The Economic Journal 121: 1340-1360. https://dx-doi-org.web.bisu.edu.cn/10.1111/j.1468-0297.2011.02450.x.

16.

Finon

Pignon

(2008). “Capacity mechanisms in imperfect electricity markets.” Utilities Policy 16(3). https://dx-doi-org.web.bisu.edu.cn/10.1016/j.jup.2008.01.006.

17.

Garcia

Shen

(2010). “Equilibrium capacity expansion under stochastic demand growth.” Operations Research 58(1): 30-42. https://dx-doi-org.web.bisu.edu.cn/10.1287/opre.1090.0719.

18.

Green

Léautier

T.-O.

(2014). “Do costs fall faster than revenues? renewable electricity subsidies dynamics.” Presentation available at http://idei.fr/doc/conf/eem/conf2014/Slides/Green.pdf.

19.

Hogan

(2005). “On an ”energy only” electricity market design for resource adequacy.” Mimeo, Center for Business and Government, John F. Kennedy School of Government, Harvard University.

20.

IEA (2010). Projected Cost of Generating Electricity. OECD/IEA.

21.

Joskow

Tirole

(2007). “Reliability and competitive electricity markets.” RAND Journal of Economics 38(1):60-84.

22.

Joskow

P. L.

(2007). “Competitive electricity markets and investment in new generating capacity.” In: Helm, D. (Ed.), The New Energy Paradigm, Oxford University Press. https://dx-doi-org.web.bisu.edu.cn/10.1111/j.1756-2171.2007.tb00044.x.

23.

Léautier

T.-O.

(2014). “The ‘demand side’ effect of price caps: Uncertainty, imperfect competition, and rationing.” Mimeo, Toulouse School of Economics.

24.

Lijesen

(2007). “The real-time price elasticity of electricity.” Energy Economics 29: 249-258. https://dx-doi-org.web.bisu.edu.cn/10.1016/j.eneco.2006.08.008.

25.

Murphy

Smeers

(2005). “Generation capacity expansion in imperfectly competitive restructured electricity markets.” Operations Research 53(4): 646-661. https://dx-doi-org.web.bisu.edu.cn/10.1287/opre.1050.0211.

26.

Ofgem (2013). Electricity capacity assessment report 2013. https://www.ofgem.gov.uk/ofgem-publications/75232/electric-ity-capacityassessment-report-2013.pdf.

27.

Oren

(2005). “Ensuring generation adequacy in competitive electricity markets.” In Griffin

Puller

editors, Electricity Deregulation: Choices and Challenges, 388-415. University of Chicago Press.

28.

Praktiknjo

A. J.

Erdmann

(2012). “Costs of blackouts and supply security in the context of climate protection and nuclear energies in germany.” Mimeo, TU Berlin, Department of Energy Systems.

29.

Stoft

(2002). Power System Economics. Wiley-Interscience.

30.

Wolak

(2004). “What’s wrong with capacity markets?” http://stoft.com/metaPage/lib/WolaK-2004-06-contract-ade-quacy.pdf. Mimeo, Department of Economics, Stanford University.

31.

Zöttl

(2011). “On optimal scarcity prices.” International Journal of Industrial Organization 29(5) :589-605. https://dx-doi-org.web.bisu.edu.cn/10.1016/j.ijindorg.2011.01.002.

Supplementary Material

Please find the following supplemental material available below.

For Open Access articles published under a Creative Commons License, all supplemental material carries the same license as the article it is associated with.

For non-Open Access articles published, all supplemental material carries a non-exclusive license, and permission requests for re-use of supplemental material or any part of supplemental material shall be sent directly to the copyright owner as specified in the copyright notice associated with the article.

0.00 MB

0.06 MB