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Capacity commitment and price volatility in a competitive electricity market

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  • Tishler, Asher
  • Milstein, Irena
  • Woo, Chi-Keung

Abstract

The long lead time required to add new capacity in the electricity generation industry means that daily demands are necessarily served by capacity already installed. However, in a competitive market, even if the installed capacity was designed to serve the projected demands, frequent surpluses and occasional full utilization inevitably lead to price volatility. This paper develops a two-stage model of the generation market in which capacity construction occurs in stage 1, before demand realization, and price determination occurs in stage 2, when the equilibrium price ensures that the realized demand does not exceed the installed capacity. We show that price volatility and price spikes are inevitable, and that while price capping can mitigate high and volatile prices, it causes unmet demands and reduction in system reliability. This paper accentuates the interdependence among generating capacity, price volatility and service reliability, a primary cause of concern in the debate on electricity market reform.

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Bibliographic Info

Article provided by Elsevier in its journal Energy Economics.

Volume (Year): 30 (2008)
Issue (Month): 4 (July)
Pages: 1625-1647

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Handle: RePEc:eee:eneeco:v:30:y:2008:i:4:p:1625-1647

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References

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Cited by:
  1. Sakellaris, Kostis, 2010. "Modeling Electricity Markets as Two-Stage Capacity Constrained Price Competition Games under Uncertainty," MPRA Paper 23317, University Library of Munich, Germany.
  2. Woo, C.K. & Li, R. & Shiu, A. & Horowitz, I., 2013. "Residential winter kWh responsiveness under optional time-varying pricing in British Columbia," Applied Energy, Elsevier, vol. 108(C), pages 288-297.
  3. Hu, Junfeng & Kwok, Gabe & Xuan, Wang & Williams, James H. & Kahrl, Fredrich, 2013. "Using natural gas generation to improve power system efficiency in China," Energy Policy, Elsevier, vol. 60(C), pages 116-121.
  4. Woo, C.K. & Zarnikau, J. & Moore, J. & Horowitz, I., 2011. "Wind generation and zonal-market price divergence: Evidence from Texas," Energy Policy, Elsevier, vol. 39(7), pages 3928-3938, July.
  5. Milstein, Irena & Tishler, Asher, 2011. "Intermittently renewable energy, optimal capacity mix and prices in a deregulated electricity market," Energy Policy, Elsevier, vol. 39(7), pages 3922-3927, July.
  6. Safarzynska, Karolina & van den Bergh, Jeroen C.J.M., 2011. "Industry evolution, rational agents and the transition to sustainable electricity production," Energy Policy, Elsevier, vol. 39(10), pages 6440-6452, October.
  7. Milstein, Irena & Tishler, Asher, 2012. "The inevitability of capacity underinvestment in competitive electricity markets," Energy Economics, Elsevier, Elsevier, vol. 34(1), pages 62-77.

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