Incentives to invest in liberalised electricity industries in the North and South. Differences in the need for suitable institutional arrangements

The issue of investment is all too often underplayed in deregulation reforms focused on market rules and de-integration measures. This presentation criticises first the optimistic approach of the theory of investment incentives through market signals when it is applied to deregulated electricity industries. The greater part of the investment in base-load and peak equipment should be made profitable by income from very high prices during peak and extreme peak periods, that raises a problem of political acceptability. The problem is then addressed in the context of the mature electricity industries in the North. Given the maturity of markets there, a number of modifications to the pure market model could be envisaged to strengthen incentives to invest, but none of them is perfect. The main way is to focus on adaptation of market rules on the Supply of power at peaks and extreme peaks by considering "capacity adequacy" as a public good (with three solutions: capacity payment, reserve obligations, centralised procurement by auctioning for peak capacity). Observation of reforms suggests also the validity of some other Solutions based on a limitation of the competition by allowing long-term contracts and vertical integration between production and Supply. Finally the question is extended to the specific problem of developing Countries characterised by irregular growth. It is argued that reforms must be designed in view of the importance of the need for investment through long-term coordination and reduction of investment risks. Indeed experiences of Latin American liberalised industries show that they have to include a number of competition-based imperfections and to allow ongoing exercise of market power in order to allow prices to rise above competition prices. The single buyer model or some variants of it appear to be good alternatives if one wishes to avoid the twists and turns of the competition paradigm. The difficulty With this model arises from the institutional conditions necessary to make it efficient and not overcostly. (c) 2005 Elsevier Ltd. All rights reserved.