Capacity commitment and price volatility in a competitive electricity market

Asher TISHLER, Irena MILSTEIN, Chi Keung WOO

Research output: Contribution to journalArticle

40 Citations (Scopus)

Abstract

The long lead time required to add new capacity in the electricity generation industry means that daily demands are necessarily served by capacity already installed. However, in a competitive market, even if the installed capacity was designed to serve the projected demands, frequent surpluses and occasional full utilization inevitably lead to price volatility. This paper develops a two-stage model of the generation market in which capacity construction occurs in stage 1, before demand realization, and price determination occurs in stage 2, when the equilibrium price ensures that the realized demand does not exceed the installed capacity. We show that price volatility and price spikes are inevitable, and that while price capping can mitigate high and volatile prices, it causes unmet demands and reduction in system reliability. This paper accentuates the interdependence among generating capacity, price volatility and service reliability, a primary cause of concern in the debate on electricity market reform. Copyright © 2007 Elsevier B.V. All rights reserved.
Original languageEnglish
Pages (from-to)1625-1647
JournalEnergy Economics
Volume30
Issue number4
DOIs
Publication statusPublished - Jul 2008

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Electricity
Industry
Power markets
Electricity market
Price volatility
Surplus
Lead time
Electricity generation
Equilibrium price
Price determination
System reliability
Market reform
Competitive market
Two-stage model
Interdependence

Bibliographical note

Tishler, A., Milstein, I., & Woo, C.-K. (2008). Capacity commitment and price volatility in a competitive electricity market. Energy Economics, 30(4), 1625-1647. doi: 10.1016/j.eneco.2007.03.005

Keywords

  • Electricity markets
  • Endogenous capacity
  • Price volatility