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Investments in Imperfect Power Markets under Carbon Pricing: A Case Study Based Analysis

This article addresses the question of how investments in imperfectly competitive electricity markets interact with a price on carbon. The analysis is based on a dynamic numerical Cournot model calibrated to the German market and focuses on (a) the level of investments and technology choice and (b) welfare impacts under optimal carbon pricing. As a special feature, we also restrict access to one technology (coal) to strategic players ("technological market power"). The main results are: (a) In the long-run prices reach competitive levels due to entry by the competitive fringe. If technological market power prevails, this can only be accomplished through high carbon prices. (b) Investment levels and technology choice show different patterns under market power and perfect competition. (c) Apart from driving investments, carbon pricing also renders old carbon-intensive capacities unprofitable and thus induces more extensive fleet turnover. (d) Welfare almost always increases as a result of carbon pricing.

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Energy Specializations: Electricity – Generation Technologies; Electricity – Markets and Prices ; Electricity – Policy and Regulation; Renewables – Wind ; Energy and the Environment – Climate Change and Greenhouse Gases

JEL Codes: L11: Production, Pricing, and Market Structure; Size Distribution of Firms, Q42: Alternative Energy Sources, Q35: Hydrocarbon Resources, Q54: Climate; Natural Disasters and Their Management; Global Warming, Q41: Energy: Demand and Supply; Prices, D47: Market Design, D42: Market Structure, Pricing, and Design: Monopoly

Keywords: Electricity markets, Market power, Investments, Carbon pricing

DOI: 10.5547/01956574.34.4.10

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Published in Volume 34, Number 4 of the bi-monthly journal of the IAEE's Energy Economics Education Foundation.