The optimal fuel mix and redistribution of social surplus in the Korean power market

This paper investigates the difference between the optimal fuel mix incorporating a pre-installed generation capacity constraint and the actual fuel mix in the Korean power market. Since the restructuring of the market, the fuel mix has been determined partly by investors and partly by the Basic Plan for Long-Term Electricity Supply and Demand (BPE). Both the system marginal price (SMP), and the capacity payment (CP), which has been based on the fixed cost of a specific gas turbine generator, were intended to provide an investment incentive in the market; however, they did not bring about an optimal fuel mix in Korea. Under the circumstances of a shortage of base load generators, these generators may garner excessive profits due to a high SMP level. However, the adjustment scheme of profit between KEPCO and Gencos left scant profit for generators. This paper suggests that a contract is needed to create the appropriate profit and tax levels for these base load generators. The redistribution of profit improves equality between consumers and generators, and the proper margin creates incentives for base load technology investment in Korea.

Research highlights
► This paper aims to determine the optimal fuel mix in Korea and shows the difference between the optimal and actual fuel mix;
► We discovered that the optimal fuel mix ratio should be 63.5%:20.5%:16.0%for nuclear energy, coal, and LNG, respectively;
► Because the pre-installed capacity is taken as given, the optimal fuel mix under the given installed capacity is an addition of a new nuclear unit to the current fuel mix;
► The additional profit above the profit margin in the BPE should be collected and redistributed to consumers;
► While we provide an incentive to build nuclear and coal units in Korea, we also suggest that a contract is needed to guarantee the profit level for generators based on a government regulation constraint, the BPE, to achieve a fair treatment.