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'Insufficient Incentives for Investment in Electricity Generation’

  • Neuhoff, K.
  • de Vries, L.

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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File URL: http://www.econ.cam.ac.uk/electricity/publications/wp/ep42.pdf
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Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 0428.

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Length: 33
Date of creation: May 2004
Date of revision:
Handle: RePEc:cam:camdae:0428
Note: CMI42, IO
Contact details of provider: Web page: http://www.econ.cam.ac.uk/index.htm

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  1. Paul L. Joskow, 1976. "Contributions to the Theory of Marginal Cost Pricing," Bell Journal of Economics, The RAND Corporation, vol. 7(1), pages 197-206, Spring.
  2. Anette Boom, 2003. "Investments in Electricity Generating Capacity under Different Market Structures and with Endogenously Fixed Demand," CIG Working Papers SP II 2003-01, Wissenschaftszentrum Berlin (WZB), Research Unit: Competition and Innovation (CIG).
  3. Palsson, Anne-Marie, 1996. "Does the degree of relative risk aversion vary with household characteristics?," Journal of Economic Psychology, Elsevier, vol. 17(6), pages 771-787, December.
  4. Besser, Janet Gail & Farr, John G. & Tierney, Susan F., 2002. "The Political Economy of Long-Term Generation Adequacy: Why an ICAP Mechanism is Needed as Part of Standard Market Design," The Electricity Journal, Elsevier, vol. 15(7), pages 53-62.
  5. Green, Richard, 2002. "Retail Competition and Electricity Contracts," Royal Economic Society Annual Conference 2002 93, Royal Economic Society.
  6. Paul Joskow & Edward Kahn, 2001. "A Quantitative Analysis of Pricing Behavior in California's Wholesale Electricity Market During Summer 2000," NBER Working Papers 8157, National Bureau of Economic Research, Inc.
  7. Littlechild, Stephen C, 2003. "Wholesale Spot Price Pass-Through," Journal of Regulatory Economics, Springer, vol. 23(1), pages 61-91, January.
  8. Turvey, R., 2003. "Ensuring adequate generation capacity," Utilities Policy, Elsevier, vol. 11(2), pages 95-102, June.
  9. Hobbs, Benjamin F. & Iñón, Javier & Stoft, Steven E., 2001. "Installed Capacity Requirements and Price Caps: Oil on the Water, or Fuel on the Fire?," The Electricity Journal, Elsevier, vol. 14(6), pages 23-34, July.
  10. Fraser, Hamish & Lo Passo, Francesco, 2003. "Developing a Capacity Payment Mechanism in Italy," The Electricity Journal, Elsevier, vol. 16(9), pages 54-58, November.
  11. Simon GB Cowan & Simon Cowan, 2002. "Utility Regulation and Risk Allocation: The Roles of Marginal Cost Pricing and Futures Markets," Economics Series Working Papers 100, University of Oxford, Department of Economics.
  12. Willis, K. G. & Garrod, G. D., 1997. "Electricity supply reliability : Estimating the value of lost load," Energy Policy, Elsevier, vol. 25(1), pages 97-103, January.
  13. Woo, Chi-Keung & Lloyd, Debra & Tishler, Asher, 2003. "Electricity market reform failures: UK, Norway, Alberta and California," Energy Policy, Elsevier, vol. 31(11), pages 1103-1115, September.
  14. Ford, Andrew, 1999. "Cycles in competitive electricity markets: a simulation study of the western United States," Energy Policy, Elsevier, vol. 27(11), pages 637-658, October.
  15. Hirst, Eric & Hadley, Stan, 1999. "Generation Adequacy: Who Decides?," The Electricity Journal, Elsevier, vol. 12(8), pages 11-21, October.
  16. Newbery, D., 2002. "Regulatory Challenges to European Electricity Liberalisation," Cambridge Working Papers in Economics 0230, Faculty of Economics, University of Cambridge.
  17. Shuttleworth, Graham, 1997. "Getting markets to clear," The Electricity Journal, Elsevier, vol. 10(3), pages 2-2, April.
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