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): market design , uniform price and discriminatory auctions , investment , electricity , regulatory reform

JEL(s): D44 , L10 , L5 , L94

Programme Areas: Industrial Organization

Link to this Page: www.cepr.org/pubs/dps/DP6626.asp.asp

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.