Operational uncertainty and the missing money problem

This study investigates how algorithmic choices in power system operations affect the total compensation available to different technologies participating in wholesale electricity markets. We focus on systems that utilize capacity payments. The need for capacity payments arises due to the “missing money” problem, i.e., that prices in short-term markets for energy and ancillary services are suppressed below the level required to support resource adequacy. Capacity payments to different technologies are calibrated under the assumption that price suppression occurs only in instances of scarcity, such that market operators can restore theoretically efficient remuneration by tying capacity payments to estimates of production during scarcity events. However, the complexity of power system operations creates challenges with short-term price formation that can lead to price suppression in non-scarcity hours. Compensating for this form of price suppression through capacity payments results in inefficient remuneration overall. In simulations using data from the New York Independent System Operator, we show that current configurations can result in elevated payments to peaking power plants relative to technologies whose production is spread over more hours of the year (e.g., nuclear, wind, and hydropower). The results reinforce the case for price formation reforms that shift the composition of overall revenue in wholesale electricity markets away from capacity toward energy and ancillary services.