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Assessing long-term effects of demand response policies in wholesale electricity markets

May 2014

Chaire European Electricity Markets / Fondation Paris-Dauphine


This paper deals with the practical problems related to long-term issues in electricity markets in the presence of demand response development.

Different policies have been implemented around the world aiming to develop demand response potential. Externalities, in particular the CO2 externality, have been one of the key elements in the debate on the effectiveness of different policies regarding demand response development. Policy makers have several options to deal with this externality. The most direct one is to correct the externality by setting a CO2 price at a level that corresponds to the cost to society of the corresponding CO2 emissions.

One alternative solution could be to subsidize carbon-free technologies as demand response. In this paper we examine potential long-term impacts of these two policies. We rely on a long-term market simulation model that characterizes expansion decisions in a competitive regime. We test for each policy two different scenarios regarding the possibility of internalization of the CO2 externality.

The results show that differences in development policies affect both investments and social costs in the wholesale electricity market and confirm previous findings that a market-driven development of demand response with the internalization of the CO2 externality is the most efficient approach.


Co-author: Mauricio Cepeda.

Published by CEEM, Working Paper 2014-6.

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