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Vertical unbundling, the coordination of investment, and network pricing

  • Gert Brunekreeft
  • Nele Friedrichsen
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    This paper provides a formal analysis on the investment coordination problem in a vertically separated electricity supply industry, although the analysis may apply also to other network industries. In an electricity system, the investment decisions of network and power plants need to be coordinated. In unbundled markets, firm-internal coordination no longer applies. We develop a formal approach to examine whether simple information exchange (“cheap talk”) could restore coordination. We adopt a three-stage profit-optimized investment model, with a (regulated) monopoly network and two asymmetrical Cournot-type generators. To analyse credibility of cheap talk we apply the concept of self-signalling in a game with incomplete information and positive spillovers. We show that cheap talk cannot generally solve the investment coordination problem and as a result separation may actually cause a costly coordination problem. We then examine locational network pricing as a coordination device to internalize the incentive problem.

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    Paper provided by Bremer Energie Institut in its series Bremen Energy Working Papers with number 0003.

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    Length: 32 pages
    Date of creation: Aug 2010
    Date of revision:
    Handle: RePEc:bei:00bewp:0003
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