Reference

Thomas-Olivier Léautier, The visible hand: ensuring optimal investment in electric power generation, The Energy Journal, vol. 37, n. 2, 2016, forthcoming.

Abstract

This article formally analyzes the various corrective mechanisms that have been proposed and implemented to alleviate underinvestment in electric power generation. It yields three main analytical findings. First, physical capacity certificates markets implemented in the United States restore optimal investment if and only if they are supplemented with a \no short sale" condition, i.e., producers can not sell more certificates than they have installed capacity. Then, they raise producers' profits beyond the imperfect competition level. Second, financial reliability options, proposed in many markets, are effective at curbing market power, although they fail to fully restore investment incentives. If \no short sale" conditions are added, both physical capacity certificates and financial reliability options are equivalent. Finally, a single market for energy and operating reserves subject to a price cap is isomorphic to a simple energy market. Standard peak-load pricing analysis applies: under-investment occurs, unless production is perfectly competitive and the cap is never binding.

JEL codes

  • L13: Oligopoly and Other Imperfect Markets
  • L94: Electric Utilities

Research partnership

Électricité de France (EDF)

Replaces

Thomas-Olivier Léautier, The Visible Hand: Ensuring Optimal Investment in Electric Power Generation, IDEI Working Paper, n. 605, September 2011, revised March 2013.