The Visible Hand: Ensuring Optimal Investment in Electric Power Generation

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.

On intermittent renewable generation & the stability of Australia's National Electricity Market

“…17 Each of these comes with problems. Introducing capacity markets represents a partial reversion to central planning which grinds against the decision to push market and investment risks away from consumers and to investors in the first place (Leautier, 2016). 18 Raising VoLL compounds the risk of, and inability to distinguish, market power (Roques et al, 2005 and others 19 ).…”

“…Thus each solution involves some form of administrative judgement, and in all cases, the risk of errorviz. exercise of market power with VoLL (Hogan, 2013); overinvestment with capacity markets (Leautier, 2016); or market power and excess reserves with FCASis ultimately borne by the customer.…”

Lessons from Australia's National Electricity Market 1998-2018: strengths and weaknesses of the reform experience

“…In real-time, participants are unable to optimise the number of VoLL events. Actions by regulatory authorities and System Operators compound matters by frequently suppressing legitimate price signals (de Vries, 2003;Wen et al 2004;Finon & Pignon, 2008;Joskow 2008, Spees et al, 2013Hogan, 2013, Leautier, 2016. Energy-only markets are therefore rarely in equilibrium, and this creates risks for the continuity of timely investment to ensure the administratively determined reliability criteria is met (Bidwell & Henney, 2004;Cramton & Stoft, 2006;de Vries & Heijien, 2008;Hirth et al 2016).…”

Strategic Behaviour in a Capacity Market? The New Irish Electricity Market Design

“…Other potential solutions include a re-design of the electricity market (Hogan (2005), Roques (2008)) and a strategic reserve. Comparisons between dierent mechanisms are provided by de Vries (2004), Cramton and Stoft (2006), Finon and Pignon (2008) and Léautier (2016).…”