Generation Capacity Investments in Electricity Markets: Perfect Competition

Abstract

In competitive electricity markets, markets designs based on power exchanges where supply bidding (barring demand-side bidding) is at the sole short run marginal cost may not guarantee resource adequacy. As alternative ways to remedy the resource adequacy problem, we focus on three different market designs in detail when demand is inelastic, namely an energy-only market with VOLL pricing (or a price cap), an additional capacity market, and operating-reserve pricing. We also discuss demand-side bidding (i.e., a price responsive demand) which can be seen as a categorically different alternative to remedy the resource adequacy problem. We consider a perfectly competitive market consisting of three types of agents: generators, a transmission system operator, and consumers; all agents are assumed to have no market power. For each market design, we model and analyze capacity investment choices of firms using a two-stage game where generation capacities are installed in the first stage and generation takes place in future spot markets at the second stage. When future spot market conditions are assumed to be known a priori (i.e., deterministic demand case), we show that all of these two-stage models with different market mechanisms, except operating-reserve pricing, can be cast as single optimization problems. When future spot market conditions are not known in advance (i.e., under demand uncertainty), we essentially have a two-stage stochastic game. Interestingly, an equilibrium point of this stochastic game can be found by solving a two-stage stochastic program, in case of all of the market mechanisms except operating-reserve pricing. In case of operatingreserve pricing, while the formulation of an equivalent deterministic or stochastic optimization problem is possible when operating-reserves are based on observed demand, this simplicity is lost when operatingreserves are based on installed capacities. We generalize these results for other uncertain parameters in spot markets such as fuel costs and transmission capacities. Finally, we illustrate how all these models can be numerically tackled and present numerical experiments. In our numerical experiments, we observe that uncertainty of demand leads to higher total generation capacity expansion and a broader mix of technologies compared to the investment decisions assuming average demand levels. Furthermore for the same VOLL (or price cap) level and under the assumptions of random demand with finite support and no forced outages, energy-only markets with VOLL pricing tend to lead to total generation capacity below the peak load with a

Introducing CO2 Allowances, Higher Prices for All Consumers; Higher Revenues for Whom?

“…We discuss the basics of the electricity market and give an overview of the electricity market investment model as presented in Gürkan et al (2012). Then, as an extension, we include either an emission constraint or a fixed carbon tax imposed by the environmental regulator.…”

“…Several two-stage models for electricity investments are available in the literature, and they can basically be separated into two streams, one dealing with imperfect competition (Murphy and Smeers (2005), Ralph and Smeers (2006), and Hu and Ralph (2007)) and the other dealing with perfect competition (Neuhoff et al (2005), Ehrenmann and Smeers (2008), Zhao et al (2010), and Gürkan et al (2012)). When there are small number of firms competing, an imperfect oligopolistic framework is believed to be a better representation of reality.…”

“…In addition, from a modeling and analyzing perspective, perfect competition first and foremost presents a benchmark for imperfect competition models and leads to more analytically tractable results; that is, assuming imperfect competition in a two-stage framework could result in an equilibrium problem with equilibrium constraints (EPEC), which is known to often be analytically intractable. We thus choose to focus on a perfectly competitive electricity market and will use and expand the model as presented by Gürkan et al (2012). Their analysis specifically focusses on capacity investments and resource adequacy in both a deterministic and a stochastic setting, which poses a good starting point for incorporating and subsequently analyzing CO2 regulation.…”

“…We first deal with a deterministic version of the model presented in Gürkan et al (2012) and extend the model to include cap-and-trade and taxation. We show that under either policy the two-stage game can be reduced to a single optimization problem, similar to what has been shown for the original problem.…”

“…Each day a second stage problem is solved, while investment decisions are made based on the expected outcome of these daily realizations. To the model as presented by Gürkan et al (2012), we again add the cap-and-trade and fixed taxation. As allowances are typically set for a certain period rather than on a daily basis, the maximum emission allowance is going to be imposed at the first stage.…”