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An Evolutionary Analysis of Investment in Electricity Markets

Manuel L. Costa and Fernando S. Oliveira ()
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Fernando S. Oliveira: Operational Research and Systems Warwick Business School

No 430, Computing in Economics and Finance 2005 from Society for Computational Economics

Abstract: Electricity markets are being liberalised and open to private competition in several countries. These liberalized electricity markets are very complex as the interactions between demand and supply are subject to several technicalities arising from the commodity being traded: electricity. One of these technicalities is that generators cannot store electricity: this fact implies that it needs to generate its production real-time. A second problem with this market are the different generation technologies used at different levels of demand, which implies that at different times of the day different generation costs are supported to meet demand: due to ramp-rate constraints, capacity available, and fixed and start-up costs. In this paper we analyze the issue of investment and the electricity system’s long-term security in an industry where a regulator controls the short-term prices, imposing a perfect competition outcome for “low†demand hours and a price cap at times where load is shed. We look at the following research questions: a) How does the oligopolistic structure of the market interact with the value of the different technologies? b) How do players define their investment strategies? c) How do the regulatory policies affect the investment in generation? Do they work similarly under perfect competition and oligopoly? d) Can markets invest enough capacity to ensure the long run security of the market? The main results of our analysis are following: 1. The impact of a given investment on the market price is independent of the player investing. 2. The impact of an investment on price is a function of the technology in which the investment takes place and of the cycle to which the price refers to. 3. The impact of price caps on the evolution of the market structure is non-linear, it cannot be too low or too high. 4. An oligopolistic electricity market fails to deliver the needed investment unless the regulators intervene. 5. The higher the reserve margin the higher the total investment. However, this instrument by itself was not able to provide the incentive needed to ensure the long-term security of the system, as in any of the experiments analyzed the peak demand is not completely satisfied. 6. Even a slight increase in demand, due to the reserve margin, leads to important changes on the relative value of the different technologies. 7. The main task of the regulatory authorities is to define a level of capacity payments that give the necessary incentive to investment, at the minimum cost: Capacity Payments are very important in shaping the generation structure. 8. Uncertainty reduces the value of Peak plants: this result clearly contradicts any common sense in these matters, as one would expect the presence of price uncertainty to be beneficial to Peak plants. The proportion invested in baseload plants increases with uncertainty of the energy price, decreasing the investment in shoulder plant.

Keywords: agent-based; electricity markets; evolution; investment; regulation; simulation (search for similar items in EconPapers)
JEL-codes: C73 D43 L11 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-com and nep-ene
Date: 2005-11-11
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