The Visible Hand: Ensuring Optimal Investment in Electric Power Generation
AbstractThis 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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Bibliographic InfoPaper provided by Institut d'Économie Industrielle (IDEI), Toulouse in its series IDEI Working Papers with number 605.
Date of creation: Sep 2011
Date of revision: Mar 2013
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Other versions of this item:
- LÃ©autier, Thomas-Olivier, 2011. "The Visible Hand: Ensuring Optimal Investment in Electric Power Generation," TSE Working Papers, Toulouse School of Economics (TSE) 10-153, Toulouse School of Economics (TSE), revised 19 Aug 2012.
- L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
- L94 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Electric Utilities
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-07-31 (All new papers)
- NEP-ENE-2010-07-31 (Energy Economics)
- NEP-REG-2010-07-31 (Regulation)
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