The Visible Hand: Ensuring Optimal Investment in Electric Power Generation

62 Pages Posted: 25 Aug 2012

See all articles by Thomas‐Olivier Léautier

Thomas‐Olivier Léautier

University of Toulouse 1 - Toulouse School of Economics (TSE)

Date Written: August 19, 2012

Abstract

This article formally analyzes the causes of underinvestment in electric power generation, and the various corrective market designs that have been proposed and implemented. It yields four main analytical findings. First, using a simple numerical example, (a linear demand function, calibrated on the French power load duration curve), strategic supply reduction is shown to be a more important cause of underinvestment than the imposition of a price cap. Second, physical capacity certificates markets implemented in the United States restore optimal investment, but increase producers' profits beyond the imperfect competition level. Third, financial reliability options, proposed in many markets, fail to restore investment incentives. If a "no short sale" condition is added, they are equivalent to physical capacity certificates. Finally, if competition is perfect, energy only markets yield a negligible underinvestment compared to the optimum. Taken together, these findings suggest that, to ensure generation adequacy, policy makers should put more effort on enforcing competitive behavior in the energy markets, and less on designing additional markets.

Keywords: imperfect competition, power market design, investment incentives

JEL Classification: L13, L94

Suggested Citation

Leautier, Thomas-Olivier, The Visible Hand: Ensuring Optimal Investment in Electric Power Generation (August 19, 2012). Available at SSRN: https://ssrn.com/abstract=2135425 or http://dx.doi.org/10.2139/ssrn.2135425

Thomas-Olivier Leautier (Contact Author)

University of Toulouse 1 - Toulouse School of Economics (TSE) ( email )

Place Anatole-France
Toulouse Cedex, F-31042
France

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