Generation Capacity Expansion in Imperfectly Competitive Restructured Electricity Markets

Abstract

We consider three models of investments in generation capacity in restructured electricity systems that differ with respect to their underlying economic assumptions. The first model assumes a perfect, competitive equilibrium. It is very similar to the traditional capacity expansion models even if its economic interpretation is different. The second model (open-loop Cournot game) extends the Cournot model to include investments in new generation capacities. This model can be interpreted as describing investments in an oligopolistic market where capacity is simultaneously built and sold in long-term contracts when there is no spot market. The third model (closed-loop Cournot game) separates the investment and sales decision with investment in the first stage and sales in the second stage-that is, a spot market. This two-stage game corresponds to investments in merchant plants where the first-stage equilibrium problem is solved subject to equilibrium constraints. We show that despite some important differences, the open-and closed-loop games share many properties. One of the important results is that the prices and quantities produced in the closed-loop game, when the solution exists, fall between the prices and quantities in the open-loop game and the competitive equilibrium.

Modeling strategic investment decisions in spatial markets

“…The results concerning production, price, consumer rent and profits for the three models are in line with the expectations based on previous work (see, e.g., Murphy and Smeers, 2005). Total production as well as consumer rent are highest in the case of a perfectly competitive market followed by the closed-loop and open-loop models.…”

“…3 Fudenberg and Tirole (1991) and the literature cited therein generally address the issue of diverging results of open-loop models in comparison to closed-loop models and provide intuition for the divergence: In the closed-loop model, in contrast to the open-loop model, a player's influence via its own actions in the first stage on the other players' actions in the second stage is taken into account. Applying this intuition to the special case of the capacity expansion problem, Murphy and Smeers (2005) show that in the closed-loop equilibrium, marginal investment costs may be higher than the sum of the short-term marginal value implied by the KKT conditions. In particular, they note that "the difference between the two characterizes the value for the player of being able to manipulate the short-term market by its first stage investments."…”

“…The existing literature on the subject, in particular the above mentioned Murphy and Smeers (2005) as well as Wogrin et al (2013b), provides general properties of closed-loop and open-loop models and conditions for diverging and non-diverging results between the two models, assuming simplified settings (e.g., ignoring existing capacities). We conjecture that in a spatial application with non-generic data and existing capacities available to the players, equilibria are likely to deviate between the two modeling approaches, which is confirmed by our application to the metallurgical coal market (see Sections 4 and 5).…”

“…In our setting, perfect competition investments lie between closed-loop and open-loop investments. In the model setup used in Murphy and Smeers (2005), investments in the perfect competition case generally exceed those in the closed-loop model. Our results are due to existing capacities, that are withheld in the closed-loop model (and thus enable profitable investments into new capacities) but are mostly utilized in the competitive case (see Figure 3 on the right).…”

A generation expansion planning model of a strategic electricity generating firm

“…Reference [15] proposes a payoff-based approach for generation expansion planning to meet the economic and efficiency requirements of the electricity market. Reference [16] presents three models for generation expansion planning. The first proposes a perfect competitive equilibrium, the second is the open loop Cournot equilibrium and the third one is the closed loop cournot equilibrium.…”