Investment in New Power Plants Under Environmental Policies

Abstract

Economists have long been in favor of deregulating or restructuring the power sector in order to promote competition. One of the motivations for doing so is to make the industry more competitive through which investment decisions, such as generation capacity and transmission expansion, are driven by market signals. The so-called market signals include those provided by environmental and energy market-based instruments, e.g., cap-and-trade (C&T)  policy and renewable portfolio standards (RPS). This chapter focuses on generation-capacity investment in the power sector. It first introduces screening-curve analysis, a common approach used by the power industry to gauge which technology is economically more (or less) favorable for given capacity factors. Inferring from existing studies, we then focus on open-loop formulations, assuming that producers simultaneously make investment and operational decisions for two reasons. First, the solutions of open-loop and closed-loop formulations have been shown to be equivalent under perfect competition. Second, a long-run equilibrium under perfect competition market entails the notion of the zero-profit condition unless there are significant entry barriers. Solutions to imperfectly competitive oligopoly formulations based on the concept of subgame perfect equilibrium (SPE) exist, but their implementations are limited to small-scale case studies, mostly theoretical studies with limited applicability to any realistic system. Thus, we present open-loop oligopoly capacity-investment models and compare their solutions to those under perfect competition. The chapter then introduces a Stackelberg leader–follower competition in which one of the firms is designated as the leader who possesses opportunities for investing in new capacity while other firms are price takers and not allowed to invest. The resulting mathematical program with equilibrium constraints (MPEC), with followers’ first-order conditions embedded in the leader’s problem, is then recast into a mixed-integer quadratic program (MIQP). The chapter concludes with discussions on possible extensions, including modeling price-containment policies, e.g., permit-price ceiling and floor, that are currently used by the Regional Greenhouse Gas Initiative (RGGI) in the U.S. and the California C&T program.