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The Visible Hand: Ensuring Optimal Investment in Electric Power Generation

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  • 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, , vol. 37(2), pages 89-109, April.
    • Handle: RePEc:sae:enejou:v:37:y:2016:i:2:p:89-109
    DOI: 10.5547/01956574.37.2.tlea
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    References listed on IDEAS

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    1. Alfredo Garcia & Zhijiang Shen, 2010. "Equilibrium Capacity Expansion Under Stochastic Demand Growth," Operations Research, INFORMS, vol. 58(1), pages 30-42, February.
    2. 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.
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