Capacity investments in a competitive energy market

Lukas Block () and Bastian Westbrock ()
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Lukas Block: Paderborn University
Bastian Westbrock: Hamburg University

No 95, Working Papers Dissertations from Paderborn University, Faculty of Business Administration and Economics

Abstract: We study the abilities of competitive markets to produce sufficient energy capacities to meet a fixed energy demand. Renewable energy producers with stochastic outputs and no variable costs compete against conventional energy producers with deterministic, pollutant outputs and increasing marginal costs. We find that either market forces are strong enough to serve the entire demand, or they are too weak such that the market fails and nothing is produced. This crucially depends on the relative cost of renewable energy investments, such that relatively cheap renewable energy causes the market to fail. Welfare analyses show that with increasing levels of conventional energy pollution the ability of the market to produce an efficient outcome further declines. As a policy implication, our findings refute the use of a strategic reserve as a blackout backstop solution. Instead, a capacity mechanism consisting of a tax-and-subsidy scheme can align the market outcome with the efficient solution for all pollution levels and relative costs of renewable energy capacities.

Keywords: Renewable versus conventional energy; capacity mechanisms; strategic reserves; capacity payments (search for similar items in EconPapers)
JEL-codes: D41 L11 Q48 (search for similar items in EconPapers)
Pages: 29
Date: 2022-04
New Economics Papers: this item is included in nep-ene, nep-env, nep-gth, nep-ind and nep-reg
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