The question of generation adequacy in liberalized electricity markets

This paper presents an overview of the reasons why unregulated markets for the production of electricity cannot be expected to invest sufficiently in generation capacity continuously. While it can be shown that periodically occurring price spikes should provide generation companies with sufficient investment incentives in theory, there are a number of probable causes of market failure. A likely result is the development of investment cycles. The experience in California shows the great social cost which an episode of scarce generation capacity may incur. A second disadvantage is that the price spikes can be manipulated by generation companies. This would result in large transfers of income from consumers to producers and reduce the operational reliability of electricity supply during these price spikes. We end this paper by outlining several methods which have been proposed to stabilize the market and which provide better incentives to generation companies and consumers alike.