electricity markets are to be made.
In the present article we thus extend the framework of investment in several technolo- gies analyzed in the peak load pricing literature for a single firm to the case of strategically interacting firms.4 In a two stage market game firms first make their investment decisions prior to the spot market which is subject to uncertain or fluctuating demand, then firms compete at the spot market. Firms can decide to invest in many different available tech- nologies, which all differ in their cost of investment and corresponding cost of production. Firms investment decisions thus determines the precise composition of industry investment in all technologies. That is, we obtain the precise shape of industry marginal cost function.5
Our main results can be summarized as follows: Most importantly we derive equilib- rium investment of strategic firms, establishing existence and uniqueness. We then compare equilibrium investment choice to the benchmark cases of perfect competition (welfare max- imization), monopoly (profit maximization) and the so called second best solution6 derived in the peak load pricing literature. Interestingly, under imperfect competition firms have a strong incentive to invest into low marginal cost technologies in order to negatively in- fluence their competitors’ spot market outputs. We are able to establish properties under which this strategic effect is so intense that equilibrium investment in low–marginal–cost technologies in oligopoly is even above the welfare optimal level.
Based on the theoretical framework developed we then empirically analyze equilibrium investment for the German electricity market. As a main result we find that investment of strategic firms7 in base–load technologies (producing at marginal cost below 25 €/MWh, such as nuclear and lignite plants) exceeds first best investment levels. Strategic under– investment takes place exclusively in middle– and peak–load technologies (such as gas, or oil-fired plants). We are furthermore able to determine the impact of strategic behavior on the entire distribution of wholesale prices in the long run.8 This allows to quantify the
4Notice that strategic investment in a single technology, i.e. capacity choice of strategic firms, has
recently received attention in the literature, see for example Murphy and Smeers (2005). How those look like is illustrated in figure 1 for the case of Germany. This second best approach maximized a weighted sum of welfare and profits. The German market consists essentially of four large players. Two of them (RWE and E.on) have a 5 6 7
market share of 26 % each, while the two smaller ones (ENBW and Vattenfall) together cover 30 % of the
market each. Compare, e.g., Monopolkommission (2007). 8Remember for the case of capacity choice in part I of the thesis, assessment of the distribution of
electricity prices was possible only for the upper tail (10%) of the price distribution. In part II we are now able to derive the entire price distribution.