IDEAS home Printed from https://ideas.repec.org/a/aen/journl/ej37-2-leautier.html
   My bibliography  Save this article

The Visible Hand: Ensuring Optimal Investment in Electric Power Generation

Author

Listed:
  • Thomas-Olivier Léautier

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.

Suggested Citation

  • Thomas-Olivier Léautier, 2016. "The Visible Hand: Ensuring Optimal Investment in Electric Power Generation," The Energy Journal, International Association for Energy Economics, vol. 0(Number 2).
  • Handle: RePEc:aen:journl:ej37-2-leautier
    as

    Download full text from publisher

    File URL: http://www.iaee.org/en/publications/ejarticle.aspx?id=2753
    Download Restriction: Access to full text is restricted to IAEE members and subscribers.
    ---><---

    As the access to this document is restricted, you may want to look for a different version below or search for a different version of it.

    Other versions of this item:

    References listed on IDEAS

    as
    1. Thomas-Olivier Leautier, 2014. "Is Mandating "Smart Meters" Smart?," The Energy Journal, International Association for Energy Economics, vol. 0(Number 4).
    2. Paul Joskow & Jean Tirole, 2007. "Reliability and competitive electricity markets," RAND Journal of Economics, RAND Corporation, vol. 38(1), pages 60-84, March.
    3. 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.
    4. 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.
    5. Lijesen, Mark G., 2007. "The real-time price elasticity of electricity," Energy Economics, Elsevier, vol. 29(2), pages 249-258, March.
    6. Severin Borenstein, 2005. "The Long-Run Efficiency of Real-Time Electricity Pricing," The Energy Journal, International Association for Energy Economics, vol. 0(Number 3), pages 93-116.
    7. Alfredo Garcia & Zhijiang Shen, 2010. "Equilibrium Capacity Expansion Under Stochastic Demand Growth," Operations Research, INFORMS, vol. 58(1), pages 30-42, February.
    8. 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.
    9. Zöttl, Gregor, 2011. "On optimal scarcity prices," International Journal of Industrial Organization, Elsevier, vol. 29(5), pages 589-605, September.
    10. D. Finon & V. Pignon, 2008. "Capacity mechanisms in imperfect electricity markets," Post-Print hal-00716763, HAL.
    11. Natalia Fabra & Nils‐Henrik M von der Fehr & María‐Ángeles de Frutos, 2011. "Market Design and Investment Incentives," Economic Journal, Royal Economic Society, vol. 121(557), pages 1340-1360, December.
    12. Frederic H. Murphy & Yves Smeers, 2005. "Generation Capacity Expansion in Imperfectly Competitive Restructured Electricity Markets," Operations Research, INFORMS, vol. 53(4), pages 646-661, August.
    13. Michael A. Crew & Paul R. Kleindorfer, 1976. "Peak Load Pricing with a Diverse Technology," Bell Journal of Economics, The RAND Corporation, vol. 7(1), pages 207-231, Spring.
    14. Boom, Anette, 2009. "Vertically integrated firms' investments in electricity generating capacities," International Journal of Industrial Organization, Elsevier, vol. 27(4), pages 544-551, July.
    15. Finon, Dominique & Pignon, Virginie, 2008. "Capacity mechanisms in imperfect electricity markets," Utilities Policy, Elsevier, vol. 16(3), pages 141-142, September.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Bublitz, Andreas & Keles, Dogan & Zimmermann, Florian & Fraunholz, Christoph & Fichtner, Wolf, 2018. "A survey on electricity market design: Insights from theory and real-world implementations of capacity remuneration mechanisms," Working Paper Series in Production and Energy 27, Karlsruhe Institute of Technology (KIT), Institute for Industrial Production (IIP).
    2. Simshauser, P., 2019. "Lessons from Australia’s National Electricity Market 1998-2018: the strengths and weaknesses of the reform experience," Cambridge Working Papers in Economics 1972, Faculty of Economics, University of Cambridge.
    3. David Brown, 2018. "Capacity Market Design: Motivation and Challenges in Alberta’s Electricity Market," SPP Briefing Papers, The School of Public Policy, University of Calgary, vol. 11(12), March.
    4. Simshauser, Paul, 2018. "On intermittent renewable generation & the stability of Australia's National Electricity Market," Energy Economics, Elsevier, vol. 72(C), pages 1-19.
    5. Paul Simshauser, 2020. "Merchant utilities and boundaries of the firm: vertical integration in energy-only markets," Working Papers EPRG2008, Energy Policy Research Group, Cambridge Judge Business School, University of Cambridge.
    6. Simshauser, Paul, 2019. "Missing money, missing policy and Resource Adequacy in Australia's National Electricity Market," Utilities Policy, Elsevier, vol. 60(C), pages 1-1.
    7. Clastres, Cédric & Khalfallah, Haikel, 2015. "An analytical approach to activating demand elasticity with a demand response mechanism," Energy Economics, Elsevier, vol. 52(PA), pages 195-206.
    8. Simshauser, Paul, 2020. "Merchant renewables and the valuation of peaking plant in energy-only markets," Energy Economics, Elsevier, vol. 91(C).
    9. Paul Simshauser & Joel Gilmore, 2020. "Is the NEM broken? Policy discontinuity and the 2017-2020 investment megacycle," Working Papers EPRG2014, Energy Policy Research Group, Cambridge Judge Business School, University of Cambridge.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Gal, Nurit & Milstein, Irena & Tishler, Asher & Woo, C.K., 2019. "Investment in electricity capacity under fuel cost uncertainty: Dual-fuel and a mix of single-fuel technologies," Energy Policy, Elsevier, vol. 126(C), pages 518-532.
    2. Gregor Zöttl, 2010. "A Framework of Peak Load Pricing with Strategic Firms," Operations Research, INFORMS, vol. 58(6), pages 1637-1649, December.
    3. Thomas-Olivier Leautier, 2014. "Is Mandating "Smart Meters" Smart?," The Energy Journal, International Association for Energy Economics, vol. 0(Number 4).
    4. Bajo-Buenestado, Raúl, 2017. "Welfare implications of capacity payments in a price-capped electricity sector: A case study of the Texas market (ERCOT)," Energy Economics, Elsevier, vol. 64(C), pages 272-285.
    5. Léautier, Thomas-Olivier, 2014. "Transmission constraints and strategic underinvestment in electric power generation," IDEI Working Papers 816, Institut d'Économie Industrielle (IDEI), Toulouse.
    6. Léautier, Thomas-Olivier, 2014. "The "demand side" effect of price caps: uncertainty, imperfect competition, and rationing," IDEI Working Papers 815, Institut d'Économie Industrielle (IDEI), Toulouse.
    7. Brown, David P., 2018. "Capacity payment mechanisms and investment incentives in restructured electricity markets," Energy Economics, Elsevier, vol. 74(C), pages 131-142.
    8. Léautier, Thomas-Olivier, 2014. "The "demand side" effect of price caps: uncertainty, imperfect competition, and ration," TSE Working Papers 14-460, Toulouse School of Economics (TSE).
    9. Klaus Eisenack & Mathias Mier, 2019. "Peak-load pricing with different types of dispatchability," Journal of Regulatory Economics, Springer, vol. 56(2), pages 105-124, December.
    10. Lorenczik, Stefan, 2019. "Interaction effects of market failure and CRMs in interconnected electricity markets," Energy Policy, Elsevier, vol. 135(C).
    11. Lambin, Xavier, 2020. "Integration of Demand Response in Electricity Market Capacity Mechanisms," Utilities Policy, Elsevier, vol. 64(C).
    12. Christian Gambardella & Michael Pahle & Wolf-Peter Schill, 2016. "Do Benefits from Dynamic Tariffing Rise? Welfare Effects of Real-Time Pricing under Carbon-Tax-Induced Variable Renewable Energy Supply," Discussion Papers of DIW Berlin 1621, DIW Berlin, German Institute for Economic Research.
    13. Pedro Linares & Xavier Labandeira, 2010. "Energy Efficiency: Economics And Policy," Journal of Economic Surveys, Wiley Blackwell, vol. 24(3), pages 573-592, July.
    14. Leautier, Thomas-Olivier, 2018. "On the long-term impact price caps: Investment, uncertainty, imperfect competition, and rationing," International Journal of Industrial Organization, Elsevier, vol. 61(C), pages 53-95.
    15. Lam, Wing Man Wynne, 2014. "Competition in the Market for Flexible Resources: an application to cloud computing," TSE Working Papers 14-518, Toulouse School of Economics (TSE).
    16. Petitet, Marie & Finon, Dominique & Janssen, Tanguy, 2017. "Capacity adequacy in power markets facing energy transition: A comparison of scarcity pricing and capacity mechanism," Energy Policy, Elsevier, vol. 103(C), pages 30-46.
    17. Fabra, Natalia, 2018. "A primer on capacity mechanisms," Energy Economics, Elsevier, vol. 75(C), pages 323-335.
    18. Chloé Coq & Henrik Orzen & Sebastian Schwenen, 2017. "Pricing and capacity provision in electricity markets: an experimental study," Journal of Regulatory Economics, Springer, vol. 51(2), pages 123-158, April.
    19. Carsten Helm & Mathias Mier, 2016. "Efficient diffusion of renewable energies: A roller-coaster ride," Working Papers V-389-16, University of Oldenburg, Department of Economics, revised Apr 2016.
    20. Joskow, Paul L., 2008. "Capacity payments in imperfect electricity markets: Need and design," Utilities Policy, Elsevier, vol. 16(3), pages 159-170, September.

    More about this item

    JEL classification:

    • F0 - International Economics - - General

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:aen:journl:ej37-2-leautier. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: . General contact details of provider: https://edirc.repec.org/data/iaeeeea.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: David Williams (email available below). General contact details of provider: https://edirc.repec.org/data/iaeeeea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.