The optimal generation capacity and investment incentives of peak units

Abstract

Taking the generator availability, operation cost and maintenance cost into consideration, a model of the optimal generation capacity for peak units is developed based on cost-benefit analysis. And the optimal capacity is calculated, from the perspective of minimal social cost and maximal investment return respectively, revealing the divergence in investment goal of society and investors. Furthermore, in reality the installed peak-load generation capacity cannot exactly meet the ideally optimal level, and the additional social cost, that is the difference of the social cost from the value at the optimal peak capacity, is asymmetric in under- and over-investment situations. Therefore over-investment, which is favored by the society because it saves much expensive lost load cost, is in contradiction to underinvestment, which is preferred by investors for lower risks. Such incompatibility in investment incentives between the society and investors is mathematically analyzed. Finally, according to the current situation of deregulation and restructuring in China's electricity sector, a proposal of raising the price cap properly to encourage generation investment is given as one of the solutions to such incompatibility. In addition, the relationship between the uplifted price cap and the stimulated generation investment is analyzed, revealing the diminishing marginal effect of price cap uplift on over-investment incentives.