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A Primer on Capacity Mechanisms

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  • Natalia Fabra

    (Universidad Carlos III de Madrid and CEPR)

Abstract

A simple model is built up to capture the key drivers of investment and pricing incentives in electricity markets. The focus is put on the interaction between market power and investment incentives, and the trade-o_ it introduces when designing the optimal regulatory instruments. In contrast to the energy-only market paradigm that assumes perfect competition, our model demonstrates that in the presence of market power scarcity prices do not promote efficient investments, even among risk-neutral investors. Combining price caps and capacity payments allows to disentangle the two-fold objective of inducing the right investment incentives while mitigating market power. Bundling capacity payments with financial obligations further mitigates market power as long as strike prices are set sufficiently close to marginal costs.
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • Natalia Fabra, 2018. "A Primer on Capacity Mechanisms," Working Papers EPRG 1806, Energy Policy Research Group, Cambridge Judge Business School, University of Cambridge.
    • Handle: RePEc:enp:wpaper:eprg1806
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    References listed on IDEAS

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    2. Paul Joskow & Jean Tirole, 2007. "Reliability and competitive electricity markets," RAND Journal of Economics, RAND Corporation, vol. 38(1), pages 60-84, March.
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    10. Joseph Bowring, 2013. "Capacity Markets in PJM," Economics of Energy & Environmental Policy, International Association for Energy Economics, vol. 0(Number 2).
    11. Natalia Fabra & Nils‐Henrik M von der Fehr & María‐Ángeles de Frutos, 2011. "Market Design and Investment Incentives," Economic Journal, Royal Economic Society, vol. 121(557), pages 1340-1360, December.
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    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Fabra, Natalia & Motta, Massimo & Peitz, Martin, 2022. "Learning from electricity markets: How to design a resilience strategy," Energy Policy, Elsevier, vol. 168(C).
    2. Keppler, Jan Horst & Quemin, Simon & Saguan, Marcelo, 2022. "Why the sustainable provision of low-carbon electricity needs hybrid markets," Energy Policy, Elsevier, vol. 171(C).
    3. Michele Fioretti & Jorge Tamayo, 2021. "Saving for a Dry Day: Coal, Dams, and the Energy Transition," Working Papers hal-03389152, HAL.
    4. Klaus Eisenack & Mathias Mier, 2019. "Peak-load pricing with different types of dispatchability," Journal of Regulatory Economics, Springer, vol. 56(2), pages 105-124, December.
    5. Astier, Nicolas & Ovaere, Marten, 2022. "Reliability standards and generation adequacy assessments for interconnected electricity systems," Energy Policy, Elsevier, vol. 168(C).
    6. Papavasiliou, Anthony & Cartuyvels, Jacques & Bertrand, Gilles & Marien, Alain, 2023. "Implementation of scarcity pricing without co-optimization in European energy-only balancing markets," Utilities Policy, Elsevier, vol. 81(C).
    7. Gholami, Mina Bahrami & Poletti, Stephen & Staffell, Iain, 2021. "Wind, rain, fire and sun: Towards zero carbon electricity for New Zealand," Energy Policy, Elsevier, vol. 150(C).
    8. Villalobos, Cristian & Negrete-Pincetic, Matías & Figueroa, Nicolás & Lorca, Álvaro & Olivares, Daniel, 2021. "The impact of short-term pricing on flexible generation investments in electricity markets," Energy Economics, Elsevier, vol. 98(C).
    9. Holmberg, Pär & Tangerås, Thomas, 2021. "Strategic Reserves versus Market-wide Capacity Mechanisms," Working Paper Series 1387, Research Institute of Industrial Economics.
    10. Gregor Zoettl, 2021. "Emission trading systems and the optimal technology mix," SERIEs: Journal of the Spanish Economic Association, Springer;Spanish Economic Association, vol. 12(2), pages 281-327, June.
    11. repec:hal:spmain:info:hdl:2441/1qif9fqehq930ovnr511k1el4f is not listed on IDEAS
    12. Natalia Fabra & Gerard Llobet, 2023. "Auctions with Privately Known Capacities: Understanding Competition Among Renewables," The Economic Journal, Royal Economic Society, vol. 133(651), pages 1106-1146.
    13. Fabra, Natalia, 2021. "The energy transition: An industrial economics perspective," International Journal of Industrial Organization, Elsevier, vol. 79(C).
    14. Benatia, David, 2022. "Ring the alarm! Electricity markets, renewables, and the pandemic," Energy Economics, Elsevier, vol. 106(C).
    15. Wildauer, Rafael & Leitch, Stuart & Kapeller, Jakob, 2020. "How to boost the European Green Deal's scale and ambition," ifso expertise 8, University of Duisburg-Essen, Institute for Socioeconomics (ifso).
    16. Peña, Juan Ignacio & Rodríguez, Rosa & Mayoral, Silvia, 2022. "Cannibalization, depredation, and market remuneration of power plants," Energy Policy, Elsevier, vol. 167(C).
    17. Alexander Haupt, 2023. "Environmental Policy and Renewable Energy in an Imperfectly Competitive Market," CESifo Working Paper Series 10524, CESifo.
    18. Heidarizadeh, Mohammad & Ahmadian, Mohammad, 2019. "Capacity certificate mechanism: A step forward toward a market based generation capacity incentive," Energy, Elsevier, vol. 172(C), pages 45-56.
    19. Mier, Mathias, 2021. "Efficient pricing of electricity revisited," Energy Economics, Elsevier, vol. 104(C).
    20. Brito-Pereira, Paulo & Rodilla, Pablo & Mastropietro, Paolo & Batlle, Carlos, 2022. "Self-fulfilling or self-destroying prophecy? The relevance of de-rating factors in modern capacity mechanisms," Applied Energy, Elsevier, vol. 314(C).
    21. Cl'emence Alasseur & Heythem Farhat & Marcelo Saguan, 2019. "A Principal-Agent approach to Capacity Remuneration Mechanisms," Papers 1911.12623, arXiv.org, revised Sep 2020.
    22. Thomaßen, Georg & Redl, Christian & Bruckner, Thomas, 2022. "Will the energy-only market collapse? On market dynamics in low-carbon electricity systems," Renewable and Sustainable Energy Reviews, Elsevier, vol. 164(C).
    23. Natalia Fabra & Massimo Motta & Martin Peitz, 2021. "Versorgungsengpässe während einer Pandemie und was dagegen getan werden kann," Wirtschaftsdienst, Springer;ZBW - Leibniz Information Centre for Economics, vol. 101(8), pages 600-603, August.
    24. Lukas Block & Bastian Westbrock, 2022. "Capacity investments in a competitive energy market," Working Papers Dissertations 95, Paderborn University, Faculty of Business Administration and Economics.
    25. repec:hal:wpspec:info:hdl:2441/1qif9fqehq930ovnr511k1el4f is not listed on IDEAS

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    More about this item

    Keywords

    scarcity pricing; market power; capacity markets; reliability options.;
    All these keywords.

    JEL classification:

    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation
    • L94 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Electric Utilities

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