Incentives for investment in new generating capacity in deregulated markets for electricity

All decisions about investments in new generators, transmission, distributed energy resources and load management is based on expectations about future market conditions. A fundamental complication for electricity is that congestion on the transmission system makes it infeasible to rely on a single market for one location as the primary source of price discovery for all locations. As a result, trading some set of prices for different locations are needed, but the number of locations must be small to ensure that there is enough liquidity in the market for reliable price discovery. This paper develops an analytical framework for evaluating forward contracts and investment decisions under the assumption that firms want to avoid financial losses (i.e. firms are risk averse). The prices and quantities of these contracts are optimized to provide an equilibrium solution between the DISCOs and the generating companies (GENCOs) with equal gains for each side of the market. Additional purchases of electricity may be made in a spot market that is characterized by infrequent price spikes during the summer months. These price spikes make the spot market very risky for the DISCOs because customers pay a fixed regulated rate to the DISCOs (i.e. The DISCOs are still in a transition period between regulation and free markets).