Restructuring Electricity When Demand is Uncertain: The Effects on Capacity Investments, Retail Prices and Welfare

Abstract

This paper proposes a stylized model of the electricity industry taking the vertical structure of the industry into account. We examine the effects of restructuring on capacity investments, retail prices and welfare, allowing for uncertain demand. We consider the following market configurations: (i) integrated monopoly, (ii) integrated duopoly with wholesale trade, and (iii) separated duopoly with wholesale trade. We find that generators install sufficient capacity to serve retail demand (thus avoiding blackouts) in all configurations. Aggregate capacity levels and retail prices are such that the separated (integrated) duopoly with wholesale trade performs best (worst) in terms of welfare.

Keywords: Electricity, Investments, Generating Capacities, Vertical Integration, Monopoly and Competition