The paper presented in this seminar is co-authored by Chloé Le Coq, Henrik Orzen and Sebastian Schwenen.

The creation of adequate investment incentives has been of great concern in the restructur-ing of the electricity sector. However, to achieve this regulators have applied different mar-ket designs across countries and regions. In this paper we employ laboratory methods to explore the relationship between market design, capacity provision and pricing in electrici-ty markets. Subjects act as firms, choosing their generation capacity and competing in uni-form price auction markets. We compare three regulatory designs: (i) a baseline price cap system that restricts scarcity rents, (ii) a price spike regime that effectively lifts these re-strictions, and (iii) a capacity market that directly rewards the provision of capacity. Re-stricting price spikes leads to underinvestment. In line with the regulatory intention both alternative designs lead to sufficient investment albeit at the cost of higher energy prices during peak periods and substantial capacity payments in the capacity market regime. To some extent these results confirm theoretical expectations. However, we also find lower than predicted spot market prices as sellers compete relatively intensely in capacities and prices. On the other hand, the capacity markets are less competitive than predicted.

Keywords: Price Caps, Electricity, Supply Function Competition. JEL Codes: C91, L13, L94

This seminar has been jointly organized by FEEM and IEFE, Bocconi University.