Appendix B. Previous Simulation Studies

This appendix reviews previous simulation studies that are relevant to the study of cyclical behavior in the western USA. Let's begin with a question remaining from the previous appendix --- would the UK capacity payment formula have performed well if it were not a convenient lever to be exercised by companies with horizontal market power?

This question was addressed by Bunn and Larsen (1992) using computer simulation. Their model calculated the profitability of new power plants and the lead time to bring the plants on line. The simulations indicated that the UK system was inherently unstable -- reliance on the capacity payments would lead to cycles of under and over capacity and highly volatile pool prices (Bunn 1994; Bunn and Larsen 1992). The volatility was not connected to abuse of the capacity payment formula by PowerGen and National Power, nor was it connected to the "strategic reaction" of the distribution companies. Rather, it was due to a combination of dynamic factors involving the size of the capacity payment, the cost of new generating units, the lead time to bring them on line and limits on investors' ability to see into the future.

This simulation study provides a useful example of the application of computer simulation to help us learn during a period of rapid change. The modeling can be especially helpful when industry leaders have a paucity of relevant experience (Lomi and Larsen 1999). The capacity payments formula has been eliminated, so their individual simulations are no longer relevant. But their style of modeling exemplifies a pragmatic approach based on the philosophy that major restructuring "should be based less upon faith in economic ideology and more upon the careful analysis of business simulation models" (Bunn 1994, p. 367).

This pragmatic philosophy makes sense as we turn our attention to the market in the western US. Let's begin by searching for simulation models which might be put to pragmatic use to study volatility in new construction.

Purpose of Computer Models
The California Energy Commission | The Northwest Power Planning Council

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