Investment Incentives and Electricity Spot Market Design
AbstractIn liberalized electricity markets strategic firms compete in an environment characterized by fluctuating demand and non-storability of electricity. While spot market design under those conditions by now is well understood, a rigorous analysis of investment incentives is still missing. Existing models, as the peak-load-pricing approach, analyze welfare optimal investment and find that optimal investment is higher with more competitive spot markets. In this article we want to extend the analysis to investment decisions of strategic firms that anticipate competition on many consecutive spot markets with fluctuating (and possibly uncertain) demand. We study how the degree of spot market competition affects investment incentives and welfare and provide an application of the model to electricity market data. Our results show that more competitive spot market prices strictly decrease investment incentives of strategic firms. The reduction of investment incentives can be so intense to even offset the beneficial impact of more competitive spot market design. Those results obtain with and without free entry. Our analysis thus demonstrates that investment incentives necessarily have to be taken into account for a meaningful assessment of proper electricity spot market design.
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Bibliographic InfoPaper provided by University of Munich, Department of Economics in its series Discussion Papers in Economics with number 11705.
Date of creation: Jun 2010
Date of revision:
Investment; demand fluctuation; cost fluctuation; spot market design;
Find related papers by JEL classification:
- D43 - Microeconomics - - Market Structure and Pricing - - - Oligopoly and Other Forms of Market Imperfection
- L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
- D41 - Microeconomics - - Market Structure and Pricing - - - Perfect Competition
- D42 - Microeconomics - - Market Structure and Pricing - - - Monopoly
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-07-17 (All new papers)
- NEP-ENE-2010-07-17 (Energy Economics)
- NEP-REG-2010-07-17 (Regulation)
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