Imperfect Competition in Electricity Markets with Renewable Generation: The Role of Renewable Compensation Policies

Abstract

We analyze the effects of commonly employed renewable compensation policies on firm behavior in an imperfectly competitive market. We consider a model where firms compete for renewable capacity in a procurement auction prior to choosing their forward contract positions and competing in wholesale electricity markets. We focus on fixed and premium-priced feed-in tariff (FIT) compensation policies. We demonstrate that the renewable compensation policy impacts both the types of resources that win the renewable auction and subsequent market competition. While firms have stronger incentives to exercise market power in wholesale markets under a premium-priced FIT, they also have increased incentives to sign pro-competitive forward contracts. Despite these countervailing incentives, in net firms have stronger incentives to exercise market power under the premium-priced policy. We find conditions under which renewable resources that are more correlated with market demand are procured under a premium-priced design, while the opposite occurs under a fixed-priced policy. If the cost efficiencies associated with the "more valuable" renewable resources are sufficiently large, then welfare is larger under the premium-priced policy despite the stronger market power incentives in the wholesale market. Finally, we consider incumbent behavior in the renewable auction when competing against entrants with more valuable resources.

Keywords: Electricity, Renewables, Market Power, Regulation, Procurement

JEL Classification: D43, L40, L51, L94, Q48