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Investment Incentives and Auction Design in Electricity Markets

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  • de Frutos, Maria-Angeles
  • Fabra, Natalia
  • Von der Fehr, Nils-Henrik M

Abstract

Motivated by the regulatory debate in electricity markets, we seek to understand how market design affects market performance through its impact on investment incentives. For this purpose, we study a two-stage game in which firms choose their capacities under demand uncertainty prior to bidding into the spot market. We analyse a number of different market design elements, including (i) two commonly used auction formats, the uniform-price and discriminatory auctions, (ii) price-caps and (iii) bid duration. We find that, although the discriminatory auction tends to lower prices, this does not imply that investment incentives at the margin are poorer; indeed, under reasonable assumptions on the shape of the demand distribution, the discriminatory auction induces (weakly) stronger investment incentives than the uniform-price format.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6626.

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Date of creation: Jan 2008
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Handle: RePEc:cpr:ceprdp:6626

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Keywords: electricity; investment; market design; regulatory reform; uniform price and discriminatory auctions;

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  1. Giulio Federico & David Rahman, 2000. "Bidding in an electricity pay-as-bid auction," Economics Papers 2001-W5, Economics Group, Nuffield College, University of Oxford, revised 01 Apr 2001.
  2. Reynolds, Stanley S. & Wilson, Bart J., 2000. "Bertrand-Edgeworth Competition, Demand Uncertainty, and Asymmetric Outcomes," Journal of Economic Theory, Elsevier, vol. 92(1), pages 122-141, May.
  3. Peter Cramton & Steven Stoft, 2007. "Why We Need to Stick with Uniform-Price Auctions in Electricity Markets," Papers of Peter Cramton 07cpm, University of Maryland, Department of Economics - Peter Cramton, revised 2007.
  4. R. Aumann, 2010. "Subjectivity and Correlation in Randomized Strategies," Levine's Working Paper Archive 389, David K. Levine.
  5. Susan Athey, 2005. "Comparing Open and Sealed Bid Auctions: Theory and Evidence from Timber Auctions," Theory workshop papers 658612000000000098, UCLA Department of Economics.
  6. Bushnell, James & Wolfram, Catherine, 2008. "Electricity Markets," Staff General Research Papers 31547, Iowa State University, Department of Economics.
  7. Susan Athey & Armin Schmutzler, 1999. "Innovation and the Emergence of Market Dominance," Working papers 99-18, Massachusetts Institute of Technology (MIT), Department of Economics.
  8. Piccione, Michele & Tan, Guofu, 1996. "Cost-Reducing Investment, Optimal Procurement and Implementation by Auctions," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 37(3), pages 663-85, August.
  9. Morten Hviid, 1990. "Sequential capacity and price choices in a duopoly model with demand uncertainty," Journal of Economics, Springer, vol. 51(2), pages 121-144, June.
  10. Robert Earle & Karl Schmedders & Tymon Tatur, 2007. "On Price Caps Under Uncertainty," Review of Economic Studies, Oxford University Press, vol. 74(1), pages 93-111.
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Cited by:
  1. Léautier, Thomas-Olivier, 2011. "The Visible Hand: Ensuring Optimal Investment in Electric Power Generation," TSE Working Papers 10-153, Toulouse School of Economics (TSE), revised 19 Aug 2012.
  2. Sakellaris, Kostis, 2010. "Modeling Electricity Markets as Two-Stage Capacity Constrained Price Competition Games under Uncertainty," MPRA Paper 23317, University Library of Munich, Germany.
  3. Marx, Leslie M. & Shaffer, Greg, 2010. "Break-up fees and bargaining power in sequential contracting," International Journal of Industrial Organization, Elsevier, vol. 28(5), pages 451-463, September.

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