ASYMMETRIC INFORMATION AND SECURITY OF SUPPLY: AN APPLICATION OF AGENCY THEORY TO ELECTRICITY MARKETS

Abstract

The recent blackouts in Italy and California have raised doubts on the ability of electricity markets to promote efficient investment in generation. Those crises affect the security of supply, which can be viewed as a public good. Several incentive mechanisms have therefore been proposed to ensure security of supply and are currently contemplated by public authorities in many countries. The aim of this paper is to analyse two of these incentive mechanisms that can be implemented by the regulator. We develop a principal-agent model with two types of generators, differentiated by their access to capital markets. We compare a capacity payment, which we model as a menu of incentive contracts with strategic reserves, which we model as a retention rule.