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'Insufficient Incentives for Investment in Electricity Generation’

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  • Neuhoff, K.
  • de Vries, L.

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.

Suggested Citation

  • Neuhoff, K. & de Vries, L., 2004. "'Insufficient Incentives for Investment in Electricity Generation’," Cambridge Working Papers in Economics 0428, Faculty of Economics, University of Cambridge.
    • Handle: RePEc:cam:camdae:0428
    Note: CMI42, IO
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    File URL: http://www.econ.cam.ac.uk/electricity/publications/wp/ep42.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    investment; electricity; consumer utility; long-term contracts;
    All these keywords.

    JEL classification:

    • D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
    • D40 - Microeconomics - - Market Structure, Pricing, and Design - - - General
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • L94 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Electric Utilities

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