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Efficiency in Wholesale Electricity Markets: On the Role of Externalities and Subsidies

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  • Sylwia Bialek
  • Burcin Unel

Abstract

This paper studies the effects of capacity market reforms that the U.S. grid operators have undertaken in response to state-level subsidies paid to emission-free electricity generation. We first derive an analytical model of energy-and-capacity markets that allows us to predict the price and resource mix effects of subsidies, as well as to understand their welfare implications. We confirm that while the subsidies, even when combined with energy consumption taxes, generally cannot achieve first-best outcomes. We also show there exists a range of subsidy rates that are welfare-enhancing when greenhouse gas externalities are taken into account. Finally, we focus on the evaluation of capacity market reforms similar to those in PJM, ISO-NE, and NYISO, finding that such reforms are likely to decrease welfare.

Suggested Citation

  • Sylwia Bialek & Burcin Unel, 2020. "Efficiency in Wholesale Electricity Markets: On the Role of Externalities and Subsidies," CESifo Working Paper Series 8673, CESifo.
    • Handle: RePEc:ces:ceswps:_8673
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    More about this item

    Keywords

    capacity markets; renewables; subsidies; welfare;
    All these keywords.

    JEL classification:

    • Q28 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Renewable Resources and Conservation - - - Government Policy
    • Q42 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Alternative Energy Sources
    • Q58 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Environmental Economics: Government Policy
    • Q41 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Demand and Supply; Prices

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