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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 causes of underinvestment in electric power generation, and the various corrective market designs that have been proposed and implemented. It yields four main analytical findings. First, using a simple numerical example, (a linear demand function, calibrated on the French power load duration curve), strategic supply reduction is shown to be a more important cause of underinvestment than the imposition of a price cap. Second, physical capacity certificates markets implemented in the United States restore optimal investment, but increase producers' profits beyond the imperfect competition level. Third, financial reliability options, proposed in many markets, fail to restore investment incentives. If a "no short sale" condition is added, they are equivalent to physical capacity certificates. Finally, if competition is perfect, energy only markets yield a negligible underinvestment compared to the optimum. Taken together, these findings suggest that, to ensure generation adequacy, policy makers should put more effort on enforcing competitive behavior in the energy markets, and less on designing additional markets.

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Bibliographic Info

Paper provided by Toulouse School of Economics (TSE) in its series TSE Working Papers with number 10-153.

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Date of creation: Sep 2011
Date of revision: 19 Aug 2012
Handle: RePEc:tse:wpaper:22641

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  1. Anette Boom, 2007. "Vertically Integrated Firms' Investments in Electricity Generating Capacities," CIE Discussion Papers 2007-14, University of Copenhagen. Department of Economics. Centre for Industrial Economics.
  2. Paul Joskow & Jean Tirole, 2004. "Reliability and Competitive Electricity Markets," Working Papers 0408, Massachusetts Institute of Technology, Center for Energy and Environmental Policy Research.
  3. Joskow, Paul L., 2006. "Competitive Electricity Markets and Investment in New Generating Capacity," Working paper 152, Regulation2point0.
  4. Anette Boom, . "Investments in Electricity Generation Capacity under Different Market Structures with Price Responsive Demand," Papers 016, Departmental Working Papers.
  5. Klemperer, Paul D & Meyer, Margaret A, 1989. "Supply Function Equilibria in Oligopoly under Uncertainty," Econometrica, Econometric Society, vol. 57(6), pages 1243-77, November.
  6. Cramton, Peter & Stoft, Steven, 2008. "Forward reliability markets: Less risk, less market power, more efficiency," Utilities Policy, Elsevier, vol. 16(3), pages 194-201, September.
  7. de Frutos, Maria-Angeles & Fabra, Natalia & Von der Fehr, Nils-Henrik M, 2008. "Investment Incentives and Auction Design in Electricity Markets," CEPR Discussion Papers 6626, C.E.P.R. Discussion Papers.
  8. Severin Borenstein & Stephen Holland, 2005. "On the Efficiency of Competitive Electricity Markets with Time-Invariant Retail Prices," RAND Journal of Economics, The RAND Corporation, vol. 36(3), pages 469-493, Autumn.
  9. 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.
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Cited by:
  1. Cédric Clastres, 2010. "Les réseaux intelligents : régulation, investissement et gestion de la demande électrique," Post-Print halshs-00539818, HAL.

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