Electricity is the lifeblood of a modern economy. Electricity is a necessity for not only firm productivity but also individuals in their everyday life. Today’s electricity market faces a variety of challenges, most of which are related to three major policy goals: sustainability, affordability, and reliability. Sustainability has become an increasingly important issue on policy agendas in recent years. Electricity production is a leading cause of greenhouse gas emissions. In fact, together with heating, electricity accounts for 40% of total global CO2 emissions.1 Shifting electricity production to renewable sources is thus one of most promising approaches to combatting climate change, and most governments have employed policies to accelerate this transition. The affordability of electricity has long been an important issue for policymakers because electricity is an essential commodity for firms and households. For instance, most governments employ redistributive policies with respect to electricity tariffs to shield low income households from high electricity expenditures. Securing the reliability of supply is a distinct challenge in electricity markets. Because electricity, in contrast to other commodities, is not storable, sufficient reserve capacity must be available at any time to match spikes in demand. Moreover, any supply shortage can cause blackouts, leaving the entire network without electricity.
Sustainability, affordability, and reliability are often called the ’energy trilemma’. Rather than aiming to achieve these goals simultaneously, policy implementation must find a balance among them. For instance, policies to accelerate the transition to sustainable production technologies have generated additional costs for end users, thereby threatening the affordability of electricity. Both Switzerland and Germany have introduced generous subsidies to stimulate the adoption of solar photovoltaic (PV) installations, the cost of which are recovered through electricity price mark-ups. Renewable electricity production, however, impacts not only affordability but also reliability. The most promising renewable technologies, solar and wind, are intermittent (uncontrollable) and provide little help in actively balancing supply and demand. Without a breakthrough in battery technology, an economy based on a large share of renewable production requires costly investments in new reserve capacity; otherwise, the risk of blackouts substantially increases.
This dissertation tackles some challenges at the intersection of sustainability, affordability, and reliability. Its main goal is to generate insight for policy design that adequately accounts for the complexity of the energy trilemma. The dissertation consists of four research papers. The first two papers (Chapters 2 and 3) discuss the relationship between environmental policies, electricity tariff design, and redistribution. The third paper (Chapter 4) focuses on green electricity as a policy to stimulate sustainable production. Finally, the fourth paper (Chapter 5) examines capacity markets as a solution to secure reliability in markets with high shares of renewables. In the following, I briefly highlight the content and results of each paper.
In the first paper, ’Welfare and Redistribution in Residential Electricity Markets with Solar Power’ (Chapter 2), my co-authors, Nicola Pavanini and Doina Radulescu, and I study the impact of subsidies to stimulate PV adoption on grid financing and redistribution. In Switzerland, as in most countries, a large proportion of electricity grid investments are covered by volumetric charges, that is, by the price of electricity. Households that install a solar panel and directly consume their own electricity forego these charges, while nevertheless benefiting from grid access. Without adjustments in grid tariffs, the increasing number of households with PV installations threatens to erode grid revenues. Moreover, mostly rich households reap the benefits of solar panels, while lower income households must bear the cost of increasing grid surcharges. Our paper is the first paper to provide insight into these issues and to propose solutions for grid tariff design, using high quality household level data that combines electricity consumption and PV data with administrative income data, as well as building information. We study a regulator that aims to achieve various solar energy targets while covering grid investment costs and attaining an equitable cost distribution. The results highlight that a regulator with equity concerns should rely on volumetric charges for grid financing, as long as PV adoption rates are moderate. Intuitively, although relying on a fixed access fee would benefit households without a solar panel, doing so would increase the grid expenditure of households with low electricity consumption, which tend to be poorer. From an efficiency perspective, however, it would be optimal to shift grid expenditure to a fixed access fee to reduce the distortion in electricity consumption.
The second paper, ’When Environmental and Redistribution Concerns Collide: The Case of Electricity Pricing’ (Chapter 3), delves further into the role of electricity prices as redistributive instruments. My co-author, Doina Radulescu, and I study the pricing of a public utility good with an externality, when a regulator can alternatively rely on income taxation. We analyse a model in which a social planner establishes electricity prices and income taxation simultaneously, while trading off inequality aversion and environmental concerns. Calibration of the model relies on high quality household-level data from one of the largest electricity providers in Switzerland as well as administrative tax data. The results show that in the absence of an externality cost the optimal price-cost mark-ups tend to be negative. That is, a regulator concerned with redistribution aims to subsidise electricity prices to shield low-income households from high energy expenditures, while financing these subsidies by increasing income taxes. With a positive externality cost the optimal price-cost mark-up shifts upward and is more likely to be positive. Notably, however, if the regulator’s inequality aversion is sufficiently high he still subsidises electricity prices despite the externality. In an extension, we consider the case where the regulator and utility are two distinct entities with diverging interests and the regulator faces uncertainty about the utility’s marginal production cost. As a result, the regulator employs a higher price-cost mark-up to reduce the information rent of a low cost utility.
In the third paper, ’Grey, Blue, or Green? Electricity Plan Choice with Heterogeneous Environmental Tastes and Consumer Inattention’ (Chapter 4), my co-author, Tamara Bischof, and I study the demand for green electricity plans. Under a green electricity plan, households pay a premium per unit of electricity consumption to support sustainable production technologies. Green electricity plans have been gaining traction in recent years and show similarities to products with social labels in other markets (e.g., fair trade). In Switzerland, households can choose among several electricity plans with increasing price premiums that are assigned labels such as conventional, hydro, or solar. Our paper leverages the structure of electricity plan options to estimate the environmental taste of households, that is, a monetary value of how much a household is willing to contribute to the environment. The estimates of environmental taste allow us to construct a demand curve for green electricity and provide novel insight into the correlation between environmental taste and a household’s level of electricity consumption. An awareness stage accounts for the presence of a default electricity plan. We find an average environmental taste of 46 CHF per year for households in our sample, with taste increasing with income, wealth, having children, and church affiliation. The awareness of households tends to be low and ranges between 20% and 50%. Based on these estimates, we show that the correlation between electricity consumption and environmental taste is low, meaning that high consumption households are more likely to choose the cheapest non-sustainable plan.
The fourth and final paper, ’Capacity Markets, Entry, and the Strategic Decision of a Producer with Market Power’ (Chapter 5), focuses on reliability. Fearing that restructured electricity markets do not provide sufficient incentives for investing in reserve capacity, policymakers in several regions have introduced capacity markets. Capacity markets require load serving entities (e.g., retailers) to guarantee in advance that their peak demand is backed by sufficient capacity. Guarantees to satisfy this obligation, which are procured through bilateral contracts or centralized auctions, provide upfront revenue for producers that enables them to invest in reserve capacity. The economic literature has produced a large body of empirical evidence on market power in electricity markets, and the introduction of capacity markets has been criticized as providing a fruitful ground for abusing that market power. Using a theoretical model, my paper studies the decision of a producer with market power when a capacity market is introduced. In this model, a monopolistic producer competes against fringe suppliers sequentially in a capacity market and a spot market. The monopolist’s capacity choice balances two effects. On the one hand, capacity expansion allows the monopolist to deter entry of new capacity in the capacity market which increases spot market revenue. On the other hand, capacity expansions reduces capacity market prices which eventually decreases monopoly rents in the capacity market. The total effect on investment depends on the size of the capacity market and the slope of the residual demand curves in the spot and capacity markets. An important means for the monopolist to generate rents is to overinvest in capacity and subsequently reduce production to increase spot market prices. Policies such as production requirements or spot price limits can reduce monopoly rents but shift the abuse of market power to the capacity market. In an empirical application to the US electricity market, I link the theoretical results to capacity market design. Using data on all US power plants from 2006 to 2015, I compare investments across grid regions with varying capacity market designs and correlate the strategic position of producers to net changes in investment. The analysis provides no evidence of systematic differences in capacity investments across capacity market designs but indicates that the strategic position of a producer is positively correlated with capacity.
