The Visible Hand: Ensuring Optimal Investment in Electric Power Generation

Thomas-Olivier Léautier

No 605, IDEI Working Papers from Institut d'Économie Industrielle (IDEI), Toulouse

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. This analysis highlight the limitations of the corrective mechanisms. This suggest that policy makers should first and foremost control and reduce the exercise of market power, then use these mechanisms as interim remedial measures.

JEL-codes: L13 L94 (search for similar items in EconPapers)
Date: 2011-09, Revised 2013-03
New Economics Papers: this item is included in nep-ene and nep-reg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Related works:
Journal Article: The Visible Hand: Ensuring Optimal Investment in Electric Power Generation (2016)
Working Paper: The Visible Hand: Ensuring Optimal Investment in Electric Power Generation (2012)
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