The Long Run Impact of Environmental Policies on Wholesale Electricity Markets: A Dynamic Competitive Analysis

Many economic analyses of the performance of wholesale electricity markets utilize static models of perfect competition. In this paper, we propose a dynamic model of a wholesale electricity market and capacity investment that incorporates two key features of electricity generation technology: minimum operating rate constraints and generation unit start-up costs. These technology features may have important implications for competitive outcomes, but can present difficulties for market analysis since they yield production non-convexities for firms. The model allows non-convexities at the firm level, while implying a convex aggregate production set, via an assumption that firms are 'small' relative to market size. A correspondence between competitive market equilibrium and the solution to a planner's problem is established for both short-run (exogenously fixed generation capacities) and long-run (endogenous capacities) dynamic models. The model provides a computational platform for assessment of environmental regulation on short-run profits and long-run investment when firms compete under dynamic constraints. Data from the Texas ERCOT market is used to calibrate the model and compute results for the short-run dynamic model. The model is then used to simulate counterfactual profits and equilibrium investment in fossil and renewable technologies under various levels of carbon prices and renewable subsidies.

Speaker: Joe Cullen, Washington University