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'Insufficient Incentives for Investment in Electricity Generation’

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Author Info
Neuhoff, K.
de Vries, L.

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Abstract

In theory, competitive electricity markets can provide incentives for efficient investment in generating capacity. We show that if consumers and investors are risk averse, investment is efficient only if investors in generating capacity can sign long-term contracts with consumers. Otherwise the uncovered price risk increases financing costs, reduces equilibrium investment levels, distorts technology choice towards less capital-intensive generation and reduces consumer utility. We observe insufficient levels of long-term contracts in existing markets, possibly because retail companies are not credible counter-parties if their final customer can switch easily. With consumer franchise, retailers can sign long-term contracts, but this solution comes at the expense of the idea of retail competition. Alternative capacity mechanisms to stimulate investment are discussed.

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Publisher Info
Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 0428.

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Length: 33
Date of creation: May 2004
Date of revision:
Handle: RePEc:cam:camdae:0428

Note: CMI42, IO
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Web page: http://www.econ.cam.ac.uk/index.htm

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Related research
Keywords: investment; electricity; consumer utility; long-term contracts;

Other versions of this item:

Find related papers by JEL classification:
D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
D40 - Microeconomics - - Market Structure and Pricing - - - General
D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
L94 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Electric Utilities

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Hung-po Chao, 1983. "Peak Load Pricing and Capacity Planning with Demand and Supply Uncertainty," Bell Journal of Economics, The RAND Corporation, vol. 14(1), pages 179-190, Spring. [Downloadable!] (restricted)
  2. Simon Cowan, 2004. "Utility Regulation and Risk Allocation: The Roles of Marginal Cost Pricing and Futures Markets," Journal of Regulatory Economics, Springer, vol. 26(1), pages 23-40, 07. [Downloadable!]
    Other versions:
  3. Shuttleworth, Graham, 1997. "Getting markets to clear," The Electricity Journal, Elsevier, vol. 10(3), pages 2-2, April. [Downloadable!] (restricted)
  4. Newbery, D., 2002. "Regulatory Challenges to European Electricity Liberalisation," Cambridge Working Papers in Economics 0230, Faculty of Economics, University of Cambridge. [Downloadable!]
  5. Anette Boom, 2003. "Investments in Electricity Generating Capacity under Different Market Structures and with Endogenously Fixed Demand," CIG Working Papers SP II 2003-01, Wissenschaftszentrum Berlin (WZB), Research Unit: Competition and Innovation (CIG). [Downloadable!]
  6. Besser, Janet Gail & Farr, John G. & Tierney, Susan F., 2002. "The Political Economy of Long-Term Generation Adequacy: Why an ICAP Mechanism is Needed as Part of Standard Market Design," The Electricity Journal, Elsevier, vol. 15(7), pages 53-62. [Downloadable!] (restricted)
  7. Ford, Andrew, 1999. "Cycles in competitive electricity markets: a simulation study of the western United States," Energy Policy, Elsevier, vol. 27(11), pages 637-658, October. [Downloadable!] (restricted)
  8. Paul L. Joskow, 1976. "Contributions to the Theory of Marginal Cost Pricing," Bell Journal of Economics, The RAND Corporation, vol. 7(1), pages 197-206, Spring. [Downloadable!] (restricted)
  9. Littlechild, Stephen C, 2003. "Wholesale Spot Price Pass-Through," Journal of Regulatory Economics, Springer, vol. 23(1), pages 61-91, January. [Downloadable!] (restricted)
  10. Palsson, Anne-Marie, 1996. "Does the degree of relative risk aversion vary with household characteristics?," Journal of Economic Psychology, Elsevier, vol. 17(6), pages 771-787, December. [Downloadable!] (restricted)
Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Adrien de Hauteclocque & Jean-Michel Glachant, 2008. "Long-term Energy Supply Contracts in European Competition Policy: Fuzzy not Crazy," Working Papers 0816, Massachusetts Institute of Technology, Center for Energy and Environmental Policy Research. [Downloadable!]
    Other versions:
  2. Elders, I. & Ault, G. & Galloway, S. & McDonald, J. & Köhler, J. & Leach, M. & Lampaditou , E., 2006. "Electricity Network Scenarios for Great Britain in 2050," Cambridge Working Papers in Economics 0609, Faculty of Economics, University of Cambridge. [Downloadable!]
  3. Roques, F.A., 2008. "Market Design for Generation Adequacy: Healing Causes rather than Symptoms," Cambridge Working Papers in Economics 0821, Faculty of Economics, University of Cambridge. [Downloadable!]
    Other versions:
  4. Roques, F. & Newbery, D.M. & Nuttall, W.J., 2004. "Generation Adequacy and Investment Incentives in Britain: from the Pool to NETA," Cambridge Working Papers in Economics 0459, Faculty of Economics, University of Cambridge. [Downloadable!]
  5. Roques, F.A. & Savva , N.S., 2006. "Price Cap Regulation and Investment Incentives under Demand Uncertainty," Cambridge Working Papers in Economics 0636, Faculty of Economics, University of Cambridge. [Downloadable!]
  6. Brunekreeft, G. & McDaniel, T., 2005. "Policy uncertainty and supply adaquacy in electric power markets," Discussion Paper 06, Tilburg University, Tilburg Law and Economic Center. [Downloadable!]
  7. Grubb, M. & Butler, L. & Sinden, G., 2005. "Diversity and Security in UK Electricity Generation: The Influence of Low Carbon Objectives," Cambridge Working Papers in Economics 0511, Faculty of Economics, University of Cambridge. [Downloadable!]
    Other versions:
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