Generation Capacity Investments in Competitive Electricity Markets: A Preliminary Assessment after 10 years of Liberalization in Europe

Balancing supply and demand in energy markets is not an easy task. Competitive markets oblige private actors to justify their investments towards their shareholders by appropriate rates of return. Consequently, electricity markets may lead to under-investments in transmission and distribution facilities, but especially also in generation capacity. For the latter, it is today well established that the spot markets are unable to offer appropriate rates of return to investors. Even spike prices which result from inflexible demand cannot recover investments on markets where high reliability is demanded. In addition to this market equilibrium problem, politicians are likely to intervene in times of price spikes. This paper analyses the developments of both the European generation park and electricity prices over the past decade, i.e., since the first market opening Directive. The paper will show that overcapacities from pre-liberalization periods currently secure electricity supply, but that the aging power plant park and the low level of investments in new generation capacities will inevitably lead to rising prices. From a theoretical perspective, the setting up of capacity forward markets could solve the problem, yet will not address its socio-political dimensions and implications. Consequently, the paper will argue for and design an appropriate policy mix including decentralized energy systems, which will ensure, according to the authors, the necessary investments into generation.