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On the effects of capacity payments in competitive electricity markets: Capacity adequacy, price cap, and reliability

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  • Milstein, Irena
  • Tishler, Asher

Abstract

This paper employs a two-stage model to assess the consequences of an easy-to-use form of capacity payments in competitive electricity markets. We show that capacity payments increase capacity and expected consumer surplus, with little or no effect on expected social welfare (expected consumer surplus plus expected profits minus the cost of using capacity payments minus expected outage costs). In addition, we demonstrate that capacity payments can substantially reduce or, sometimes, fully eliminate electricity outage costs due to price capping or unexpected failure of some generation capacity. Thus, regulators should consider using this form of capacity payments since, in addition to their favorable effect on consumers and on social welfare, they mitigate the ‘missing money’ problem and increase system reliability.

Suggested Citation

  • Milstein, Irena & Tishler, Asher, 2019. "On the effects of capacity payments in competitive electricity markets: Capacity adequacy, price cap, and reliability," Energy Policy, Elsevier, vol. 129(C), pages 370-385.
  • Handle: RePEc:eee:enepol:v:129:y:2019:i:c:p:370-385
    DOI: 10.1016/j.enpol.2019.02.028
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    8. Mier, Mathias, 2021. "Efficient pricing of electricity revisited," Energy Economics, Elsevier, vol. 104(C).
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    10. Simshauser, P., 2020. "Merchant utilities and boundaries of the firm: vertical integration in energy-only markets," Cambridge Working Papers in Economics 2039, Faculty of Economics, University of Cambridge.
    11. Komorowska, Aleksandra & Benalcazar, Pablo & Kaszyński, Przemysław & Kamiński, Jacek, 2020. "Economic consequences of a capacity market implementation: The case of Poland," Energy Policy, Elsevier, vol. 144(C).
    12. Thomas Pownall & Iain Soutar & Catherine Mitchell, 2021. "Re-Designing GB’s Electricity Market Design: A Conceptual Framework Which Recognises the Value of Distributed Energy Resources," Energies, MDPI, vol. 14(4), pages 1-26, February.
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    More about this item

    Keywords

    Capacity payments; Missing money; Outage costs; Electricity markets; Endogenous capacity;
    All these keywords.

    JEL classification:

    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • L94 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Electric Utilities
    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity

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