The Role of Storage in a Competitive Electricity Market and the Effects of Climate Change

This paper uses a new model of a competitive electricity market to investigate the role of storage in markets dominated by hydro generation. Competition amongst generators leads to an endogenous shadow price of stored water, which facilitates the efficient intra-day and inter-season substitution of fuel. Overall welfare depends on storage capacity, the cost structure of non-hydro generators, and the characteristics of water inflows. If climate change reduces the long-run average level of inflows or leads to the introduction of a carbon tax then overall welfare will fall and the profitability of generators will rise. The welfare benefits from additional storage capacity will increase if climate change makes long-term inflows less predictable or leads to the introduction of a carbon tax. They will decrease if average inflows fall or the predictable seasonal cycle in inflows becomes less pronounced