DP6626 Investment Incentives and Auction Design in Electricity Markets

Author(s): Maria-Angeles de Frutos, Natalia Fabra, Nils-Henrik M Von der Fehr
Publication Date: January 2008
Keyword(s): electricity, investment, market design, regulatory reform, uniform price and discriminatory auctions
JEL(s): D44, L10, L5, L94
Programme Areas: Industrial Organization
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=6626

Motivated by the regulatory debate in electricity markets, we seek to understand how market design affects market performance through its impact on investment incentives. For this purpose, we study a two-stage game in which firms choose their capacities under demand uncertainty prior to bidding into the spot market. We analyse a number of different market design elements, including (i) two commonly used auction formats, the uniform-price and discriminatory auctions, (ii) price-caps and (iii) bid duration. We find that, although the discriminatory auction tends to lower prices, this does not imply that investment incentives at the margin are poorer; indeed, under reasonable assumptions on the shape of the demand distribution, the discriminatory auction induces (weakly) stronger investment incentives than the uniform-price format.