Capacity expansion and investment as a function of electricity market structure: Part I - Generation

This paper concerns the problem of capacity expansion and investment as the electric power industry undergoes major restructuring worldwide. In particular, the objectives of investment in fully regulated industry are compared with the capacity expansion in a spot only market. It is concluded that the incentives in spot only markets depend on the rules for bidding functions into the market: If only short-run marginal cost bidding curves are allowed, and no margin on forecast demand is added, basically no new investment will take place. On the other hand, if it is allowed to bid average costs, instead of short-run marginal costs, this would provide sufficiently strong incentive signals to ensure necessary installed capacity. Given that today´s measurements of market power in the spot market classify any bids higher than the short-run marginal cost as market power, we suggest that it is essential to introduce other means of providing incentives to install capacity in a timely manner. This can be done by designing longer-term physical and/or financial mechanisms for valuing future investments. In this paper we propose a stratum electricity market (SEM) structure which consists of several sequentially clearing sub-markets, ranging from a day-ahead-market (DAM), through month-, season-, year-, five year- and even ten year-forward sub- markets. The performance of this newly proposed SEM is illustrated using simulations on a simple power system in which four different types of generation technologies supply system load.