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Reliability and Competitive Electricity Markets

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  • Paul L. Joskow
  • Jean Tirole

Abstract

Despite all of the talk about deregulation' of the electricity sector, a large number of non-market mechanisms have been imposed on emerging competitive wholesale and retail markets. These mechanisms include spot market price caps, operating reserve requirements, non-price rationing protocols, and administrative protocols for managing system emergencies. Many of these mechanisms have been carried over from the old regime of regulated monopoly and continue to be justified as necessary responses to market imperfections of various kinds and engineering requirements dictated by the special physical attributes of electric power networks. This paper seeks to bridge the gap between economists focused on designing competitive market mechanisms and engineers focused on the physical attributes and engineering requirements they perceive as being needed for operating a reliable electric power system. The paper starts by deriving the optimal prices and investment program when there are price-insensitive retail consumers, and their load serving entities can choose any level of rationing they prefer contingent on real time prices. It then examines the assumptions required for a competitive wholesale and retail market to achieve this optimal price and investment program. The paper analyses the implications of relaxing several of these assumptions. First, it analyzes the interrelationships between regulator-imposed price caps, capacity obligations, and system operator procurement, dispatch and compensation arrangements. It goes on to explore the implications of potential network collapses, the concomitant need for operating reserve requirements and whether market prices will provide incentives for investments consistent with these reserve requirement.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10472.

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Date of creation: May 2004
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Publication status: published as Joskow, Paul and Jean Tirole. "Reliability and Competitive Electricity Markets." RAND Journal of Economics 38, 1 (Spring 2007): 60-84.
Handle: RePEc:nbr:nberwo:10472

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  1. Allaz Blaise & Vila Jean-Luc, 1993. "Cournot Competition, Forward Markets and Efficiency," Journal of Economic Theory, Elsevier, vol. 59(1), pages 1-16, February.
  2. Littlechild, S.C., 2000. "Why We Need Electricity Retailers: A Reply to Joskow on Wholesale Spot Price pass-through," Cambridge Working Papers in Economics 0008, Faculty of Economics, University of Cambridge.
  3. Joskow, P. & Tirole, J., 2004. "‘Retail Electricity Competition’," Cambridge Working Papers in Economics 0430, Faculty of Economics, University of Cambridge.
  4. Frank Wolak, 2000. "An Empirical Analysis of the Impact of Hedge Contracts on Bidding Behavior in a Competitive Electricity Market," International Economic Journal, Taylor & Francis Journals, Taylor & Francis Journals, vol. 14(2), pages 1-39.
  5. Chao, Hung-po & Wilson, Robert, 1987. "Priority Service: Pricing, Investment, and Market Organization," American Economic Review, American Economic Association, vol. 77(5), pages 899-916, December.
  6. Newbery, D. M., 1997. "Competition, Contracts and Entry in the Electricity Spot Market," Cambridge Working Papers in Economics 9707, Faculty of Economics, University of Cambridge.
  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. Green, Richard, 1999. "The Electricity Contract Market in England and Wales," Journal of Industrial Economics, Wiley Blackwell, vol. 47(1), pages 107-24, March.
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