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Reliability and Competitive Electricity Markets

  • Joskow, Paul
  • Tirole, Jean

Despite all of the talk about “deregulation” of the electricity sector, a large number of non-market mechanisms have been imposed on emerging competitive wholesale and retail markets. These mechanisms include spot market price caps, operating reserve requirements, non-price rationing protocols, and administrative protocols for managing system emergencies. Many of these mechanisms have been carried over from the old regime of regulated monopoly and continue to be justified as necessary responses to market imperfections of various kinds and engineering requirements dictated by the special physical attributes of electric power networks. This paper seeks to bridge the gap between economists focused on designing competitive market mechanisms and engineers focused on the physical attributes and engineering requirements they perceive as being needed for operating a reliable electric power system. The paper starts by deriving the optimal prices and investment program when there are price-insensitive retail consumers, and their load serving entities can choose any level of rationing they prefer contingent on real time prices. It then examines the assumptions required for a competitive wholesale and retail market to achieve this optimal price and investment program. The paper analyses the implications of relaxing several of these assumptions. First, it analyzes the interrelationships between regulator-imposed price caps, capacity obligations, and system operator procurement, dispatch and compensation arrangements. It goes on to explore the implications of potential network collapses, the concomitant need for operating reserve requirements and whether market prices will provide incentives for investments consistent with these reserve requirements.

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Paper provided by Institut d'Économie Industrielle (IDEI), Toulouse in its series IDEI Working Papers with number 310.

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Date of creation: Oct 2004
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Publication status: Published in The RAND Journal of Economics, vol.�38, n°1, 2007, p.�60-84.
Handle: RePEc:ide:wpaper:2122
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  1. Joskow, P. & Tirole, J., 2004. "‘Retail Electricity Competition’," Cambridge Working Papers in Economics 0430, Faculty of Economics, University of Cambridge.
  2. Allaz Blaise & Vila Jean-Luc, 1993. "Cournot Competition, Forward Markets and Efficiency," Journal of Economic Theory, Elsevier, vol. 59(1), pages 1-16, February.
  3. Peter Cramton & Steven Stoft, 2005. "A Capacity Market that Makes Sense," Papers of Peter Cramton 05licap, University of Maryland, Department of Economics - Peter Cramton, revised 2005.
  4. Chao, Hung-po & Wilson, Robert, 1987. "Priority Service: Pricing, Investment, and Market Organization," American Economic Review, American Economic Association, vol. 77(5), pages 899-916, December.
  5. Severin Borenstein & Stephen Holland, 2005. "On the Efficiency of Competitive Electricity Markets with Time-Invariant Retail Prices," RAND Journal of Economics, The RAND Corporation, vol. 36(3), pages 469-493, Autumn.
  6. Frank Wolak, 2000. "An Empirical Analysis of the Impact of Hedge Contracts on Bidding Behavior in a Competitive Electricity Market," International Economic Journal, Taylor & Francis Journals, vol. 14(2), pages 1-39.
  7. Littlechild, S.C., 2000. "Why We Need Electricity Retailers: A Reply to Joskow on Wholesale Spot Price pass-through," Cambridge Working Papers in Economics 0008, Faculty of Economics, University of Cambridge.
  8. Green, Richard, 1999. "The Electricity Contract Market in England and Wales," Journal of Industrial Economics, Wiley Blackwell, vol. 47(1), pages 107-24, March.
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