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The Convergence of Market Designs for Adequate Generating Capacity

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Abstract

This paper compares market designs intended to solve the resource adequacy (RA) problem, and finds that, in spite of rivalrous claims, the most advanced designs have nearly converged. The original dichotomy between approaches based on long-term energy contracts and those based on short-term capacity markets spawned two design tracks. Long-term contracts led to call-option obligations which provide market-power control and the ability to strengthen performance incentives, but this approach fails to replace the missing money at the root of the adequacy problem. Hogan’s energy-only market fills this gap. On the other track, the short-term capacity markets (ICAP) spawned long-term capacity market designs. In 2004, ISO New England proposed a short-term market with hedged performance incentives essentially based on high spot prices. In 2005 we developed for New England a forward capacity market with load obligated to purchase a target level of capacity covered by an energy call option. The two tracks have now converged on two conclusions: (1) High real-time energy prices should provide performance incentives. (2) High energy prices should be hedged with call options. We argue that two more conclusions are needed: (3) Capacity targets rather than high and volatile spot prices should guide investment, and (4) long-term physically based options should be purchased in a forward market for capacity. The result will be that adequacy is maintained, performance incentives are restored, market power and risks are reduced from present levels, and prices are hedged down to a level below the present price cap.

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File URL: http://www.cramton.umd.edu/papers2005-2009/cramton-stoft-market-design-for-resource-adequacy.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 06mdfra.

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Length: 72 pages
Date of creation: 2006
Date of revision: 2006
Publication status: Published in Working Paper, University of Maryland, April 2006
Handle: RePEc:pcc:pccumd:06mdfra

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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; uniform-price auctions;

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References

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  1. Peter Cramton & Steven Stoft, 2005. "A Capacity Market that Makes Sense," Papers of Peter Cramton, University of Maryland, Department of Economics - Peter Cramton 05licap, University of Maryland, Department of Economics - Peter Cramton, revised 2005.
  2. Paul Joskow & Jean Tirole, 2004. "Reliability and Competitive Electricity Markets," Working Papers, Massachusetts Institute of Technology, Center for Energy and Environmental Policy Research 0408, Massachusetts Institute of Technology, Center for Energy and Environmental Policy Research.
  3. Oren, Shmuel S., 2005. "Generation Adequacy via Call Options Obligations: Safe Passage to the Promised Land," The Electricity Journal, Elsevier, Elsevier, vol. 18(9), pages 28-42, November.
  4. Bushnell, James, 2005. "Electricity Resource Adequacy: Matching Policies and Goals," The Electricity Journal, Elsevier, Elsevier, vol. 18(8), pages 11-21, October.
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Citations

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Cited by:
  1. Cepeda, Mauricio & Saguan, Marcelo & Finon, Dominique & Pignon, Virginie, 2009. "Generation adequacy and transmission interconnection in regional electricity markets," Energy Policy, Elsevier, Elsevier, vol. 37(12), pages 5612-5622, December.
  2. Meunier, Guy, 2010. "Capacity choice, technology mix and market power," Energy Economics, Elsevier, Elsevier, vol. 32(6), pages 1306-1315, November.
  3. Gürkan, G. & Ozdemir, O. & smeers, Y., 2013. "Generation Capacity Investments in Electricity Markets: Perfect Competition," Discussion Paper, Tilburg University, Center for Economic Research 2013-045, Tilburg University, Center for Economic Research.
  4. Léautier, Thomas-Olivier, 2011. "The Visible Hand: Ensuring Optimal Investment in Electric Power Generation," IDEI Working Papers, Institut d'Économie Industrielle (IDEI), Toulouse 605, Institut d'Économie Industrielle (IDEI), Toulouse, revised Mar 2013.
  5. Peter Cramton & Steven Stoft, 2008. "Forward Reliability Markets: Less Risk, Less Market Power, More Efficiency," Papers of Peter Cramton, University of Maryland, Department of Economics - Peter Cramton 08frm, University of Maryland, Department of Economics - Peter Cramton, revised 2008.
  6. Muratore, Gabriella, 2011. "Incentive based energy market design," European Journal of Operational Research, Elsevier, Elsevier, vol. 213(2), pages 422-429, September.
  7. Talat S. Genc & Henry Thille, 2009. "Investment in Electricity Markets with Asymmetric Technologies," Working Papers, University of Guelph, Department of Economics and Finance 0909, University of Guelph, Department of Economics and Finance.
  8. repec:reg:wpaper:152 is not listed on IDEAS
  9. Cepeda, Mauricio & Finon, Dominique, 2013. "How to correct for long-term externalities of large-scale wind power development by a capacity mechanism?," Energy Policy, Elsevier, Elsevier, vol. 61(C), pages 671-685.
  10. Poletti, Steve, 2009. "Government procurement of peak capacity in the New Zealand electricity market," Energy Policy, Elsevier, Elsevier, vol. 37(9), pages 3409-3417, September.
  11. Peter Cramton & Steven Stoft, 2007. "Colombia Firm Energy Market," Papers of Peter Cramton, University of Maryland, Department of Economics - Peter Cramton 07cfem, University of Maryland, Department of Economics - Peter Cramton, revised 2007.
  12. Ausubel, Lawrence M. & Cramton, Peter, 2010. "Using forward markets to improve electricity market design," Utilities Policy, Elsevier, Elsevier, vol. 18(4), pages 195-200, December.
  13. Perez, Yannick & Ramos Real, Francisco Javier, 2008. "How to make a European integrated market in small and isolated electricity systems? The case of the Canary Islands," Energy Policy, Elsevier, Elsevier, vol. 36(11), pages 4159-4167, November.
  14. Alfredo Garcia & Ennio Stacchetti, 2011. "Investment dynamics in electricity markets," Economic Theory, Springer, Springer, vol. 46(2), pages 149-187, February.
  15. Roques, Fabien A., 2008. "Market design for generation adequacy: Healing causes rather than symptoms," Utilities Policy, Elsevier, Elsevier, vol. 16(3), pages 171-183, September.
  16. Joskow, Paul L., 2008. "Capacity payments in imperfect electricity markets: Need and design," Utilities Policy, Elsevier, Elsevier, vol. 16(3), pages 159-170, September.
  17. Finon, Dominique & Pignon, Virginie, 2008. "Electricity and long-term capacity adequacy: The quest for regulatory mechanism compatible with electricity market," Utilities Policy, Elsevier, Elsevier, vol. 16(3), pages 143-158, September.
  18. Finon, Dominique & Meunier, Guy & Pignon, Virginie, 2008. "The social efficiency of long-term capacity reserve mechanisms," Utilities Policy, Elsevier, Elsevier, vol. 16(3), pages 202-214, September.
  19. 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, Elsevier, vol. 38(10), pages 5758-5769, October.

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