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Insufficient Incentives for Investment in Electricity Generation

Karsten Neuhoff () and Laurens de Vries

Cambridge Working Papers in Economics from Faculty of Economics, University of Cambridge

Abstract: In theory, competitive electricity markets can provide incentives for efficient investment in generating capacity. We show that if consumers and investors are risk averse, investment is efficient only if investors in generating capacity can sign long-term contracts with consumers. Otherwise the uncovered price risk increases financing costs, reduces equilibrium investment levels, distorts technology choice towards less capital-intensive generation and reduces consumer utility. We observe insufficient levels of long-term contracts in existing markets, possibly because retail companies are not credible counter-parties if their final customer can switch easily. With consumer franchise, retailers can sign long-term contracts, but this solution comes at the expense of the idea of retail competition. Alternative capacity mechanisms to stimulate investment are discussed.

Keywords: investment; electricity; consumer utility; long-term contracts (search for similar items in EconPapers)
JEL-codes: D11 D40 D52 L94 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-com
Date: 2004-05
Note: CMI42, IO
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