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Capacity mechanisms and the technology mix in competitive electricity markets

Author

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  • Par Holmberg

    (IFN, Stockholm)

  • Robert A. Ritz

    (EPRG, University of Cambridge)

Abstract

Capacity mechanisms are increasingly used in electricity market design around the world yet their role remains hotly debated. In this paper, we introduce a new benchmark model of a capacity mechanism in a competitive electricity market with many different generation technologies. We consider two policy instruments, a wholesale price cap and a capacity payment, and show which combinations of these instruments induce socially-optimal investment by the market. Changing the price cap or capacity payment affects investment only in peak generation plant, with no equilibrium impact on baseload or mid-merit plant. We obtain a rationale for a capacity mechanism based on the internalization of a system-cost externality – even where the price cap is set at the value of lost load. In extensions, we show how increasing renewables penetration enhances the need for a capacity mechanism, and outline an optimal design of a strategic reserve with a discriminatory capacity payment.
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • Par Holmberg & Robert A. Ritz, 2019. "Capacity mechanisms and the technology mix in competitive electricity markets," Working Papers EPRG1921, Energy Policy Research Group, Cambridge Judge Business School, University of Cambridge.
  • Handle: RePEc:enp:wpaper:eprg1921
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    References listed on IDEAS

    as
    1. Paul Joskow & Jean Tirole, 2007. "Reliability and competitive electricity markets," RAND Journal of Economics, RAND Corporation, vol. 38(1), pages 60-84, March.
    2. Gerard Llobet and Jorge Padilla, 2018. "Conventional Power Plants in Liberalized Electricity Markets with Renewable Entry," The Energy Journal, International Association for Energy Economics, vol. 0(Number 3).
    3. Joskow, Paul L., 2008. "Capacity payments in imperfect electricity markets: Need and design," Utilities Policy, Elsevier, vol. 16(3), pages 159-170, September.
    4. David Newbery and Michael Grubb, 2015. "Security of Supply, the Role of Interconnectors and Option Values : insights from the GB Capacity Auction," Economics of Energy & Environmental Policy, International Association for Energy Economics, vol. 0(Number 2).
    5. Michael A. Crew & Paul R. Kleindorfer, 1976. "Peak Load Pricing with a Diverse Technology," Bell Journal of Economics, The RAND Corporation, vol. 7(1), pages 207-231, Spring.
    Full references (including those not matched with items on IDEAS)

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    Cited by:

    1. Tómasson, Egill & Söder, Lennart, 2020. "Coordinated optimal strategic demand reserve procurement in multi-area power systems," Applied Energy, Elsevier, vol. 270(C).

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    More about this item

    Keywords

    Investment; wholesale electricity market; capacity mechanism; capacity auction; strategic reserve;
    All these keywords.

    JEL classification:

    • D41 - Microeconomics - - Market Structure, Pricing, and Design - - - Perfect Competition
    • L94 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Electric Utilities

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