Optimal Investment in Electricity Generation in the Texas Market

Abstract

This paper estimates an indicator of the investment that would occur under competitive procurement in Texas, and the associated efficiency gains. The paper presents a method to estimate the optimal investment in each technology available to generate electricity. The method determines the optimal investment by applying a similar logic that Borenstein (2005) uses to find the optimal long run capacity, but takes into consideration the current capacity. The estimation considers the expected entry and exit of generation plants and variations in future fuel prices. I conclude that for demand elasticities between -0.025 and -0.5, the investment in baseload (or coal) units that would generate a positive social surplus for all years from 2006 to 2011, ranges from about 12 to 37 thousand megawatts hour. Independent of the realized investment in baseload units, it is not optimal to invest in new peak or mid-merit units from 2006 to 2011. In a given year, the associated efficiency gains lie between, approximately, 865 and 7,617 million dollars depending on the year and assumption of demand elasticity. The equivalent per consumer figure ranges from, approximately, $43 to $380 per year. Introduction of carbon emission costs reduces substantially the investment in coal units that maximizes the social surplus. Considering a carbon allowance price is equal to two times that of the level in Europe, the optimal investment in coal units drops to zero. Introduction of carbon emission costs does not transform combined cycle or combustion turbine technologies into attractive technologies for investment.