Reliability and Competitive Electricity Markets

52 Pages Posted: 20 May 2004

See all articles by Paul L. Joskow

Paul L. Joskow

Alfred P. Sloan Foundation; Massachusetts Institute of Technology (MIT) - Department of Economics

Jean Tirole

University of Toulouse 1 - Industrial Economic Institute (IDEI); University of Toulouse 1 - Groupe de Recherche en Economie Mathématique et Quantitative (GREMAQ); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 3 versions of this paper

Date Written: April 21, 2004

Abstract

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.

JEL Classification: L1, L9, L5

Suggested Citation

Joskow, Paul L. and Tirole, Jean, Reliability and Competitive Electricity Markets (April 21, 2004). Available at SSRN: https://ssrn.com/abstract=543862 or http://dx.doi.org/10.2139/ssrn.543862

Paul L. Joskow (Contact Author)

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Jean Tirole

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University of Toulouse 1 - Groupe de Recherche en Economie Mathématique et Quantitative (GREMAQ) ( email )

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Centre for Economic Policy Research (CEPR)

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United Kingdom

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