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A Capacity Market that Makes Sense

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Abstract

We argue that a capacity market is needed in most restructured electricity markets, and present a design that avoids the many problems found in the early capacity markets. The proposed locational capacity market pays suppliers based on their demonstrated ability to supply energy or reserves in shortage hours—hours in which there is a shortage of operating reserves. Thus, only supply that contributes to reliability is rewarded. The capacity price responds to market conditions. When capacity is scarce the capacity price is high; when capacity is plentiful the capacity price is low or zero. Market power in the capacity market is addressed by setting the capacity price based on actual capacity, rather than bid capacity, so generators cannot increase the capacity price by withholding supply. Ex post peak energy rents (the short-run energy profits of a benchmark peaking unit) are subtracted from the capacity price. Thus, a supplier does not have an incentive to create real-time shortages—the high shortage price resulting from a shortage is subtracted from the capacity price, so there is no net gain from the high price. By defining a capacity product closely tied to reliability and directly addressing market power both in the capacity market and in the spot energy market, the proposed design results in a market participants can trust to encourage efficient behavior both in the short run and long run.

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File URL: http://www.cramton.umd.edu/papers2005-2009/cramton-stoft-a-capacity-market-that-makes-sense.pdf
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Bibliographic Info

Paper provided by University of Maryland, Department of Economics - Peter Cramton in its series Papers of Peter Cramton with number 05licap.

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Length: 13 pages
Date of creation: 2005
Date of revision: 2005
Publication status: Published in Electricity Journal, 18, 43-54, August/September 2005
Handle: RePEc:pcc:pccumd:05licap

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Postal: Economics Department, University of Maryland, College Park, MD 20742-7211
Phone: (202) 318-0520
Fax: (202) 318-0520
Web page: http://www.cramton.umd.edu

Related research

Keywords: Auctions; Electricity Auctions; Capacity Auctions; Market Design;

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References

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  1. Hobbs, Benjamin F. & Iñón, Javier & Stoft, Steven E., 2001. "Installed Capacity Requirements and Price Caps: Oil on the Water, or Fuel on the Fire?," The Electricity Journal, Elsevier, vol. 14(6), pages 23-34, July.
  2. Peter Cramton, 2000. "Review of the Reserves and Operable Capability Markets: New England's Experience in the First Four Months," Papers of Peter Cramton 99reserves, University of Maryland, Department of Economics - Peter Cramton, revised 03 Jan 2000.
  3. Besser, Janet Gail & Farr, John G. & Tierney, Susan F., 2002. "The Political Economy of Long-Term Generation Adequacy: Why an ICAP Mechanism is Needed as Part of Standard Market Design," The Electricity Journal, Elsevier, vol. 15(7), pages 53-62.
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Cited by:
  1. Nagl, Stephan, 2013. "The Effect of Weather Uncertainty on the Financial Risk of Green Electricity Producers under Various Renewable Policies," EWI Working Papers 2013-15, Energiewirtschaftliches Institut an der Universitaet zu Koeln.
  2. Amundsen, Eirik S. & Bergman, Lars, 2007. "Provision of operating reserve capacity: Principles and practices on the Nordic Electricity Market," MPRA Paper 10861, University Library of Munich, Germany.
  3. Tishler, Asher & Milstein, Irena & Woo, Chi-Keung, 2008. "Capacity commitment and price volatility in a competitive electricity market," Energy Economics, Elsevier, vol. 30(4), pages 1625-1647, July.
  4. Hung-po Chao & Shmuel S Oren & Alex Papalexopoulos & Dejan J Sobajic & Robert Wilson, 2005. "Interface between Engineering and Market Operations in Restructured Electricity Markets," Levine's Bibliography 784828000000000222, UCLA Department of Economics.
  5. Sebastian Schwenen, 2012. "Strategic Bidding in Multi-unit Auctions with Capacity Constrained Bidders: The New York Capacity Market," RSCAS Working Papers 2012/62, European University Institute.
  6. Böckers, Veit & Giessing, Leonie & Haucap, Justus & Heimeshoff, Ulrich & Rösch, Jürgen, 2012. "Braucht Deutschland einen Kapazitätsmarkt für Kraftwerke? Eine Analyse des deutschen Marktes für Stromerzeugung," DICE Ordnungspolitische Perspektiven 24, Heinrich‐Heine‐Universität Düsseldorf, Düsseldorf Institute for Competition Economics (DICE).
  7. Creti, Anna & Fabra, Natalia, 2007. "Supply security and short-run capacity markets for electricity," Energy Economics, Elsevier, vol. 29(2), pages 259-276, March.
  8. Vahl, Fabrício Peter & Rüther, Ricardo & Casarotto Filho, Nelson, 2013. "The influence of distributed generation penetration levels on energy markets," Energy Policy, Elsevier, vol. 62(C), pages 226-235.
  9. Finon, Dominique & Pignon, Virginie, 2008. "Electricity and long-term capacity adequacy: The quest for regulatory mechanism compatible with electricity market," Utilities Policy, Elsevier, vol. 16(3), pages 143-158, September.
  10. Höffler, Felix & Wambach, Achim, 2013. "Investment Coordination in Network Industries: The Case of Electricity Grid and Electricity," EWI Working Papers 2013-12, Energiewirtschaftliches Institut an der Universitaet zu Koeln.
  11. Woo, C.K. & Kollman, E. & Orans, R. & Price, S. & Horii, B., 2008. "Now that California has AMI, what can the state do with it?," Energy Policy, Elsevier, vol. 36(4), pages 1366-1374, April.
  12. Álvaro López-Peña & Efraim Centeno & Julián Barquín, 2009. "Long term issues to be addressed by regulators in liberalised electricity systems: generation adequacy and indicative planning. Justification, available mechanisms, and a simulation study on some conc," RSCAS Working Papers 2009/67, European University Institute.
  13. Batlle, Carlos & Pérez-Arriaga, Ignacio J., 2008. "Design criteria for implementing a capacity mechanism in deregulated electricity markets," Utilities Policy, Elsevier, vol. 16(3), pages 184-193, September.
  14. Peter Cramton & Steven Stoft, 2006. "The Convergence of Market Designs for Adequate Generating Capacity," Papers of Peter Cramton 06mdfra, University of Maryland, Department of Economics - Peter Cramton, revised 2006.
  15. James Bushnell, 2011. "Building Blocks: Investment in Renewable and Nonrenewable Technologies," RSCAS Working Papers 2011/53, European University Institute.
  16. Tishler, A. & Newman, J. & Spekterman, I. & Woo, C.K., 2008. "Assessing the options for a competitive electricity market in Israel," Utilities Policy, Elsevier, vol. 16(1), pages 21-29, March.
  17. Böckers, Veit & Giessing, Leonie & Rösch, Jürgen, 2013. "The green game changer: An empirical assessment of the effects of wind and solar power on the merit order," DICE Discussion Papers 104, Heinrich‐Heine‐Universität Düsseldorf, Düsseldorf Institute for Competition Economics (DICE).
  18. Elberg, Christina & Kranz, Sebastian, 2013. "Capacity Mechanisms and Effects on Market Structure," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 79811, Verein für Socialpolitik / German Economic Association.
  19. Batlle, C. & Rodilla, P., 2010. "A critical assessment of the different approaches aimed to secure electricity generation supply," Energy Policy, Elsevier, vol. 38(11), pages 7169-7179, November.
  20. Moreno, R. & Barroso, L.A. & Rudnick, H. & Mocarquer, S. & Bezerra, B., 2010. "Auction approaches of long-term contracts to ensure generation investment in electricity markets: Lessons from the Brazilian and Chilean experiences," Energy Policy, Elsevier, vol. 38(10), pages 5758-5769, October.
  21. Nagl, Stephan, 2013. "Prices vs. Quantities: Incentives for Renewable Power Generation - Numerical Analysis for the European Power Market," EWI Working Papers 2013-4, Energiewirtschaftliches Institut an der Universitaet zu Koeln.

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