A Pricing Mechanism to Jointly Mitigate Market Power and Environmental Externalities in Electricity Markets

TL;DR

This paper proposes a novel incentive-based market clearing mechanism for electricity markets that addresses both market power and environmental externalities, especially under incomplete information about generation costs.

Contribution

It introduces a new market design that integrates remedies for market conduct and environmental externalities, overcoming limitations of traditional price caps.

Findings

The mechanism effectively mitigates market power.

It accounts for environmental externalities in market clearing.

It performs well under incomplete information conditions.

Abstract

The electricity industry has been one of the first to face technological changes motivated by sustainability concerns. Whilst efficiency aspects of market design have tended to focus upon market power concerns, the new policy challenges emphasise sustainability. We argue that market designs need to develop remedies for market conduct integrated with regard to environmental externalities. Accordingly, we develop an incentive-based market clearing mechanism using a power network representation with a distinctive feature of incomplete information regarding generation costs. The shortcomings of price caps to mitigate market power, in this context, are overcome with the proposed mechanism.