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Increasing the reliability of electricity production: a cost-benefit analysis

  • Mark Lijesen

This report analyses three instruments aimed at increasing the reliability of electricity production. Read also the accompanying press release and Special Publication ' Energy policies and risks on energy markets; a cost-benefit analysis '. In the system of capacity markets, the transmission system operator (TSO) requires traders to back their own peak load plus a prescribed level of spare capacity with contracted capacity, the latter being tradable at secondary markets. With reserve contracts, the TSO contracts spare capacity from producers, holding it to be dispatched in case of a crisis. Capacity payments are a subsidy on capital costs, giving producers an incentive to build more capacity. These measures prove to be inefficient in preventing price spikes, as the welfare costs of price spikes are lower than the costs of the policy options unless price spikes occur in an implausibly high frequency. Capacity payments cannot prevent black-outs, as they do not induce enough investments in spare capacity. Black-outs can be prevented by capacity markets and reserve contracts, but at a high cost. Even if a 24-hour black-out of the Randstad area occurred every five years, it would be cheaper to accept the consequences of the black-out than to prevent it.

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Paper provided by CPB Netherlands Bureau for Economic Policy Analysis in its series CPB Document with number 52.

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Date of creation: Mar 2004
Date of revision:
Handle: RePEc:cpb:docmnt:52
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  1. Richard Green, 2005. "Electricity and Markets," Oxford Review of Economic Policy, Oxford University Press, vol. 21(1), pages 67-87, Spring.
  2. David F. Layton & Klaus Moeltner, 2000. "A Censored Random Coefficients Model for Pooled Survey Data with Application to the Estimation of Power Outage Costs," Econometric Society World Congress 2000 Contributed Papers 0912, Econometric Society.
  3. Serra, Pablo & Fierro, Gabriel, 1997. "Outage costs in Chilean industry," Energy Economics, Elsevier, vol. 19(4), pages 417-434, October.
  4. 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.
  5. Tishler, Asher, 1993. "Optimal production with uncertain interruptions in the supply of electricity : Estimation of electricity outage costs," European Economic Review, Elsevier, vol. 37(6), pages 1259-1274, August.
  6. Machiel Mulder & S. Speck, 2003. "Competition on European energy markets: between policy ambitions and practical restrictions," CPB Document 33, CPB Netherlands Bureau for Economic Policy Analysis.
  7. Jeroen de Joode & Douwe Kingma & Mark Lijesen, 2004. "Energy policies and risks on energy markets; a cost-benefit analysis," CPB Special Publication 51, CPB Netherlands Bureau for Economic Policy Analysis.
  8. Joskow, Paul L & Tirole, Jean, 1999. "Transmission Rights and Market Power on Electric Power Networks I: Financial Rights," CEPR Discussion Papers 2093, C.E.P.R. Discussion Papers.
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