Vertical Unbundling and the Coordination of Investment in Electric Systems – On ‘Cheap Talk’ and deep charging

Bremen Energy Working Papers No. 03, August 2010

(published in Competition and Regulation in Network Industries, 16(5), 2015, 378-403)

Gert Brunekreeft and Nele Friedrichsen

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This paper addresses the investment coordination problem in a vertically separated electricity supply industry in the absence of locational pricing. In an electricity system, investments in network and power plants need to be coordinated. Unbundling eliminates firm-internal coordination. Information exchange might restore coordination if communication is truthful. Based on model results we analyse whether cheap talk of generator investors would be credible and hence informative for network investment decisions. We show that due to perverse incentives, this is not generally the case. We propose cost-reflective, locational network pricing as a coordination device to internalize the incentive problem.