The Economics of Electricity Markets

5Achieving Efficient Use of Generation and Load Resources using a Market Mechanism in an Industry with no Network Constraints

In Chapter 4, we explored the characteristics of efficient dispatch of a set of generation and consumption assets. In this chapter, we explore whether or not that outcome might be achieved using decentralised competitive markets in which market participants act independently to pursue their own ends. To keep things simple, in this chapter we will ignore network constraints.

5.1 Decentralisation, Competition and Market Mechanisms

Chapter 4 focused on the question of how an omniscient system operator would efficiently utilise a set of generation and consumption assets. In principle, no matter how the electricity industry is organised, given enough information and enough control powers, an omniscient system operator could achieve an efficient dispatch of generation and consumption resources, and thereby achieve an economically efficient short-run outcome.

However, in the longer term, achieving economically efficient outcomes is not just a matter of information flows and control powers. Instead, achieving economically efficient outcomes is a matter of getting the incentives right – including incentives for efficiency, investment, innovation, cooperation and coordination.

Experience shows that achieving effective incentives in large vertically integrated businesses is difficult. These problems are significantly more severe when the business is government owned. ...