The Impact of Electricity Market Reform on Investment

Electricity markets are being reformed around the world. But their ability to deliver investment in power generation capacity is being intensely debated in the aftermath of California's power crisis in 2000 and 2001. The issue is whether open and competitive markets will deliver adequate investment to ensure a secure supply of electricity.

The International Energy Agency (IEA) released today Security of Supply in Electricity Markets: Evidence and Policy Issues, which analyses the impact of market reform on investment in the power industry. It shows that, despite the problems experienced in California, the international picture is reassuring. Investment in generation and network infrastructures has taken place and OECD electricity markets are generally reliable. Where electricity prices are sufficiently high, investment has generally flowed into the electricity market. Not surprisingly, where prices are low, investment has been modest.

The publication also examines potential weak points in the new system and the measures available to minimise risks. The new electricity markets are not yet fully developed and three areas require particular attention:

  • Price signals must be accurate. Electricity prices are often distorted by policy interventions and regulatory measures, such as subsidies and price caps. The wrong price signal will discourage suppliers from investing in certain types of asset, e.g. peaking capacity.
  • Appropriate regulatory frameworks for investment and the entry of new players are needed. Authorisation and siting processes for electricity assets may not be well adapted to the needs of a competitive market.
  • Effective tools to hedge risks are essential for adequate investment.

Security of Supply in Electricity Markets: Evidence and Policy Issues also identifies some areas, including the further development of transmission networks, where investment is urgently needed to eliminate bottlenecks, facilitate trade and increase reliability. The message is clear: energy policies can play a large role in promoting adequate investment or hindering it.