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

Abstract

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.