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The Visible Hand: Ensuring Optimal Investment in Electric Power Generation

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  • Léautier, Thomas-Olivier

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. This analysis highlight the limitations of the corrective mechanisms. This suggest that policy makers should first and foremost control and reduce the exercise of market power, then use these mechanisms as interim remedial measures.

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Paper provided by Institut d'Économie Industrielle (IDEI), Toulouse in its series IDEI Working Papers with number 605.

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Date of creation: Sep 2011
Date of revision: Mar 2013
Handle: RePEc:ide:wpaper:22628

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  1. Anette Boom, 2007. "Vertically Integrated Firms' Investments in Electricity Generating Capacities," CIE Discussion Papers, University of Copenhagen. Department of Economics. Centre for Industrial Economics 2007-14, University of Copenhagen. Department of Economics. Centre for Industrial Economics.
  2. Peter Cramton & Steven Stoft, 2006. "The Convergence of Market Designs for Adequate Generating Capacity," Papers of Peter Cramton 06mdfra, University of Maryland, Department of Economics - Peter Cramton, revised 2006.
  3. Peter Cramton & Steven Stoft, 2008. "Forward Reliability Markets: Less Risk, Less Market Power, More Efficiency," Papers of Peter Cramton 08frm, University of Maryland, Department of Economics - Peter Cramton, revised 2008.
  4. Klemperer, Paul D & Meyer, Margaret A, 1989. "Supply Function Equilibria in Oligopoly under Uncertainty," Econometrica, Econometric Society, Econometric Society, vol. 57(6), pages 1243-77, November.
  5. Paul L. Joskow & Jean Tirole, 2004. "Reliability and Competitive Electricity Markets," NBER Working Papers 10472, National Bureau of Economic Research, Inc.
  6. de Frutos, Maria-Angeles & Fabra, Natalia & Von der Fehr, Nils-Henrik M, 2008. "Investment Incentives and Auction Design in Electricity Markets," CEPR Discussion Papers, C.E.P.R. Discussion Papers 6626, C.E.P.R. Discussion Papers.
  7. Severin Borenstein & Stephen P. Holland, 2003. "On the Efficiency of Competitive Electricity Markets With Time-Invariant Retail Prices," NBER Working Papers 9922, National Bureau of Economic Research, Inc.
  8. repec:reg:wpaper:152 is not listed on IDEAS
  9. Anette Boom, . "Investments in Electricity Generation Capacity under Different Market Structures with Price Responsive Demand," Papers, Departmental Working Papers 016, Departmental Working Papers.
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Cited by:
  1. Cédric Clastres & Haikel Khalfallah, 2014. "An analytical approach for elasticity of demand activation with demand response mechanisms," Working Papers halshs-01019679, HAL.
  2. Cédric Clastres, 2010. "Les réseaux intelligents : régulation, investissement et gestion de la demande électrique," Post-Print halshs-00539818, HAL.

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