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Insufficient incentives for investment in electricity generations

  • Neuhoff, Karsten
  • De Vries, Laurens

In theory, competitive electricity markets can provide incentives for efficient investment in generating capacity. We show that if consumers and investors are risk averse, investment is efficient only if investors in generating capacity can sign long-term contracts with consumers. Otherwise the uncovered price risk increases financing costs, reduces equilibrium investment levels, distorts technology choice towards less capital-intensive generation and reduces consumer utility. We observe insufficient levels of long-term contracts in existing markets, possibly because retail companies are not credible counter-parties if their final customer can switch easily. With consumer franchise, retailers can sign long-term contracts, but this solution comes at the expense of the idea of retail competition. Alternative capacity mechanisms to stimulate investment are discussed.

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Article provided by Elsevier in its journal Utilities Policy.

Volume (Year): 12 (2004)
Issue (Month): 4 (December)
Pages: 253-267

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Handle: RePEc:eee:juipol:v:12:y:2004:i:4:p:253-267
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/30478

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  2. Joskow, P. & Edward Kahn, 2002. "A Quantitative Analysis of Pricing Behavior In California’s Wholesale Electricity Market During Summer 2000," Cambridge Working Papers in Economics 0211, Faculty of Economics, University of Cambridge.
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