Market competition and strategic choices of electric power sources under fluctuating demand

Abstract

This study investigates the effects of the introduction of a competitor on the behavior of an incumbent electricity producer who used to be a local monopolist. We especially focus on its implications for the incumbent's decision of capacity choice between two different electric power sources: one with a relatively high production cost (peak-load technology), which is represented by gas-fired power generation, and the other with a relatively high capacity-building cost (base-load technology), which is represented by nuclear power generation. We assume that the entrant does not have access to the latter technology, and also that demand fluctuates over time, as is typically the case with any electricity market. We show that the introduction of a competitor increases the capacity of nuclear power generation if and only if the nuclear power capacity is sufficiently costly to establish, in comparison with the marginal production cost of a gas-fired plant. This result also implies that the competition tends to decrease the nuclear capacity when the level of carbon tax, which raises the relative production cost of gas-fired power generation, is sufficiently high.