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Free Electricity Market Could Lead To Power Shortages

June 22, 2004

Because the free electricity market in its current form does not lead to sufficient investments in power plants, the price of electricity could become very high and a shortages could occur. This conclusion was reached by Ir. Laurens de Vries in his PhD research project. He will defend his thesis at TU Delft on Tuesday 29 June. De Vries: "Liberalised electricity markets such as in the Netherlands are vulnerable to under-investment." De Vries proposes the implementation of a capacity mechanism.

On the 1st of July 2004 the electricity market will officially become a free market. De Vries, of the faculty of Technology Policy and Management of TU Delft, researched the current European market to determine if it is robust enough to guarantee the delivery of electricity. De Vries: "The question is whether there are enough economic stimuli to encourage the electricity producers to invest in the reliability of their product so that they can guarantee the delivery of their product long term."
De Vries' research shows that this is not the case. He therefore proposes the implementation of a capacity mechanism. This guarantees a sufficient level of investments in production capacity.

The goal of a capacity mechanism is to provide a timely warning that new production capacity is necessary. This would keep power shortages to a minimum. De Vries' would like to see a capacity mechanism implemented in which option-contracts are sold to producers. This has the added benefit for the consumer that the price of electricity would become more stable. There are two variants within this system. In the first case, TenneT (the system administrator) buys the contracts, in the second case, the producers are required to buy contracts.
The buyer of a contract has the right to obtain power at a set proce. "It is actually a sort of insurance," says De Vries. "This system also prevents producers from holding back capacity during shortage periods to push the price upwards, which happened during the power crisis in California."

Recently, the Minister of Economic Affairs put forward a motion which would require TenneT to distribute more contracts for reserve capacity. "This would indeed improve the investment stimulus, which should lead to more capacity. It is a good first step," says De Vries, "But, the use of option-contracts is necessary to ensure that these investments do not leak onto the open European market, which would cause them to loose their benefit for the Dutch consumer." Because option-contracts in the current market are not developing well enough on their own, De Vries believes that they should be obligatory.

Delft University of Technology