Investment risk allocation in decentralised electricity markets. The need of long-term contracts and vertical integration

None of the far-reaching experiments in electricity industry liberalisation was able to ensure the timely and optimal capacity mix development. The theoretical market model features market failures due to the specific volatility of prices, and the difficulty of creating complete markets for hedging. In this paper, we focused on a specific failure, i.e. the impossibility of allocating the various risks borne by the producer onto suppliers and consumers in order to allow capacity development. Promotion of short-term competition by mandating vertical de-integration tends to distort investments in generation by impeding efficient risk allocation. Copyright 2008 The Author. Journal compilation 2008 Organization of the Petroleum Exporting Countries.