Research

We study equilibrium contract adoption in retail electricity markets in which consumers differ in their willingness to pay over time and can choose between a fixed-price contract (FP) and real-time pricing contract (RTP). Self-selection alters the consumption profile and, in turn, the cost of serving FP customers, creating an adverse-selection channel with endogenous costs. In a competitive retail segment, this channel unravels the FP contract, any private retailer that attracts FP customers is left with a pool that is too costly to serve at break-even. Under a regulated monopoly offering the FP contract, contract choice instead disciplines pricing, the monopoly internalizes consumer sorting to the RTP contract and may cut its price to retain low-cost customers. This pricing response can increase inefficient peak consumption and reduce welfare relative to a benchmark without an RTP contract. We characterize the monopoly’s pricing rule, show how consumer heterogeneity governs the strength of the sorting incentive, and discuss regulatory instruments (two-part tariffs and loss-financing rules) that mitigate the welfare cost of opt-in RTP contracts.

This paper examines the challenges of allocating a good subject to capacity constraints such as electricity when considering consumer preferences and investment decisions. A theoretical framework is developed where a market designer sequentially chooses a level of investment and proposes an allocation mechanism to consumers followed by a consumption stage. The market designer uses the allocation to maximize consumer surplus and finance the investment cost. He faces heterogeneous consumers who have private information about their demand level and belong to a publicly observed category, allowing the market designer to distinguish groups of consumers such as households or industries. We show that the optimal allocation implies discriminating against consumers based on their types and categories and that the relative discrimination depends on the level of investment considered. It has significant welfare and distributive implications - an optimal pricing mechanism can minimize the investment cost and lead to a higher aggregate consumer surplus. However, it is not always a Pareto improvement for every consumer, especially for smaller ones. We describe two main environments - the current second-best situation, in which the market designer cannot obtain information about consumers and must choose fixed prices ex-ante, and the optimal theoretical second-best allocation mechanism that considers the incentive and individual rationality constraints and the investment decisions.

This paper studies the provision of an essential good with time-varying uncertain stochastic demand and capacity-constrained producers such as electricity or medical supplies. Due to price regulation, public good externalities, and market power, investments are typically under-procured by private agents. To restore efficient investment level, we analyze the design of reservation markets where producers can sell their capacity availability before the demand is known. While their direct effect on investment decisions is well known, we focus on indirect effects generated by their implementation, namely how the capacity price is allocated on the demand side and how the realized demand of the essential good is accounted for in the market design. We develop a novel approach to studying the reservation market's interdependencies and the subsequent production and retail markets for the essential good. We provide a sequential analytical model of the three markets and describe how different market design regimes can indirectly affect the equilibria in the production and retail markets in terms of prices, investment level, and welfare. In particular, we demonstrate that the ability of the reservation market to restore the social optimum, or at least to reach a second-best optimum, crucially depends on the different design regimes of the reservation market, on the assumptions of policy interventions, and the various market inefficiencies. The model results and the associated policy implication are discussed first using a general framework and then in reference to electricity markets where capacity reservation is often used to ensure adequate investment to ensure the security of supplies.

In many countries, capacity markets have been put in place to supplement wholesale markets revenues to ensure an adequate generation capacity to maintain security of supply. This paper studies the bidding behavior in those markets and how it can be affected by different capacity product designs. A capacity market allows producers to lock in revenues in advance in exchange for their commitment to being available over a future period on wholesale markets. Producers' participation depends on the opportunity cost of making the investment available. When the commitment is made, the profitability of the plant is uncertain. The canonical framework is based on a net present value model, where the capacity bid is equal to the expected loss on the energy market. However, this does not recognize managerial flexibility and assumes that the plant cannot react to future market conditions. Thus, we propose a novel approach to conceptualize capacity bids using real options theory, where the opportunity cost is represented as an option on the spread that drives the profitability of the plant. First, we define a bid in a one-period capacity market as a European Put Option. Then, we expand to a multi-period setting in which capacity bids can be evaluated as a modified Basket Option. Our model provides new insights on the interplay between the product/commitment duration and on capacity bid. Using the real options approach, the model presents a first attempt to untangle the different drivers of the opportunity cost for providing capacity availability. We analyze the determinants of the option value concomitantly with the length of the procurement and deduce some policy implications for the product's design. Finally, we provide a numerical illustration of this issue using data from the French power system.

Several markets are characterized by incumbents who are forced by the regulatory authorities to make part of their productive investments available to their competitors. In this paper, we study the equilibrium and welfare effect of such regulation where the incumbent who produces in a wholesale market and sells in a retail market is forced to offer parts of its productive capacity to an independent retailer. We assume that an incumbent producer competes with an independent producer via a multi-unit auction wholesale market. Both firms offer a step function and are capacity-constrained. The incumbent firm owns a retailer that competes à la Cournot with an independent retailer. We first describe the effect of vertical integration in that context. Then, we show how allocating part of the production capacity to the independent retailer changes the equilibrium in both markets. Then, we analyze the optimal capacity offered that maximizes welfare.

One of the fundamental dimensions of the investment decision is risk. This is particularly true for electricity producers because they are significant investments with long lifetimes and face significant uncertainties. To study this problem, we will establish in the first part a theoretical basis of risk analysis. We will present the approaches allowing players to value a risky investment in different ways. In particular, we will underline that each approach involves the analysis of a particular risk, but also specific assumptions about the relationship that an economic actor has with the risk. In a second part, we will propose a model describing a simplified version of a power plant. This representation will allow us to model in a complex way the estimates of income that an actor can receive in the electricity markets. The objective of this second part is to represent a risk profile specific to the revenues of a power plant. To do this, we will use empirical data from the French electricity market as well as several scenarios allowing us to have different assumptions about the players. This first model will be followed by an application of the valuation approaches proposed in the first step. This third part will thus give a risk-adjusted value of the income received in the electricity markets. We will conclude by analyzing the results of this valuation, which will shed light both on the theoretical questions raised by the use of the different methods, but also on the risks that may be observed on the electricity market in France during the period studied.

We study the effects of different product designs on an investment value in the context of capacity markets. We simulate the future profits of a hypothetical nuclear using a single project valuation model. It allows representing the imperfection of the energy market and the bids associated with the participation in a capacity market. We find that the procurement characteristics, namely the period when investors receive the remuneration, and the length of the obligation period, significantly modify the investment value if we assume they receive what they offer. The introduction of risk aversion doesn’t fundamentally change the results of the risk-neutral case even though it can significantly lower the investment value. Furthermore, we find that the approach used to model risk matters when comparing the effect of different capacity products. Further extensions of the model would highlight other indirect effects of capacity markets while giving interesting empirical results.