THE COEVOLUTION OF MARKET AND REGULATION: THE CASE OF ELECTRICITY MARKETS

Electricity market restructuring started in the late 1980s to overcome inefficiencies of the monopoly structure, such as high prices and overcapacity. Yet, three decades later, the liberalized electricity markets in several countries are still not working efficiently. Since their restructuring, electricity markets are in constant evolution due to the increasing number of stakeholders, changing market boundaries and technological improvements. When regulation does not change at the same pace with the market, the main policy objectives of sustainability, reliability and affordability become inaccessible. Ideally, regulation should address, even foresee all market challenges, and coevolve with its market. Ensuring the match between electricity markets and their regulation becomes even more challenging with rising climate change awareness and the nuclear energy debate. Many jurisdictions aim at replacing traditional generation technologies with renewables to reduce carbon emissions. However, these clean technologies create a need for intervention as on the one hand, their high upfront capital costs discourage investments and, on the other hand, their close to zero marginal costs distort market prices; consequently, the market signals no longer guide investments. These cost dynamics, coupling with the intermittency of renewables, endanger the security of supply. This thesis elaborates on the coevolution of markets and their regulation to limit the risk of regulatory failures. We start by developing a behavioural framework for the regulation of electricity markets. First, we propose four generic stages of liberalized electricity markets (monopoly, wholesale competition, retail competition, reregulation), with their respective characteristics, regulatory aims and challenges. Then we identify behavioural factors (feedback and long-term commitment, stakeholders and attitudinal factors), which exert a significant influence on electricity market regulation. We continue by discussing problematic interactions between markets and their regulation at each stage, linking these issues with these behavioural elements. This work highlights the importance of integrating behavioural factors when designing regulatory frameworks to achieve a farsighted and agile regulation which requires less adaptations. In the remainder of the thesis, we focus on an electricity market aiming to transition towards a higher share of renewables to reduce carbon emissions. We develop a system dynamics model to analyse the effect of regulatory interventions on market performance. First, we study how supporting a long-term target towards more renewables by a set of intermediate targets influences the market trajectory. We optimize regulatory decisions which ensure reaching the targets, while managing the trade-off between blackout risk and cost for customers. We find that intermediate targets lead to higher shares of renewables early on, while presenting only a long-term target results in the postponement of the market transition. In case of an early increase in the share of renewables, thermal profitability is affected negatively: this creates a need for subsidies for thermal capacity to ensure an adequate level of supply. These findings underline the trade-off between affordability and sustainability, as greener markets early on come with higher cost for customers. Next, using the same model, we aim to validate these insights with laboratory experiments, observing human decision making in the context of electricity market regulation. The optimization algorithm is replaced by human decision makers: participants who act as regulators to achieve the long-term target. We present different scenarios to test the effect of the presence and time granularity of intermediate targets on regulatory decisions and market performance. Our findings suggest that presenting intermediate targets does not necessarily facilitate reaching the final point, but influences the trajectory towards it in terms of efficiency and cost consciousness. The experimental study and the optimization yield contradictory results: in the latter, presenting only the final target delays market transition, while in the experiment, the reverse holds. We argue that almost daily exposure of participants to the impacts of climate change might be the cause of this difference, leading the participants to focus on climate change while deciding. In conclusion, this thesis focuses on the influence of behavioural factors on continuously evolving electricity markets. We underline the importance of the match between markets and their regulation to avoid unintended consequences. Using an interdisciplinary approach, we show that presenting milestones together with a long-term target shape the market trajectory, thus constitutes an effective tool for policy makers to address the market needs. The differences between optimization study and laboratory experiments further emphasize the need of integrating behavioural factors while designing regulatory frameworks