A Primer on Capacity Mechanisms

Natalia Fabra

Cambridge Working Papers in Economics from Faculty of Economics, University of Cambridge

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.

Keywords: scarcity pricing; market power; capacity markets; reliability options (search for similar items in EconPapers)
JEL-codes: L13 L51 L94 (search for similar items in EconPapers)
Date: 2018-02-13
New Economics Papers: this item is included in nep-com, nep-ene, nep-ind and nep-reg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (40)

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Related works:
Journal Article: A primer on capacity mechanisms (2018)
Working Paper: A Primer on Capacity Mechanisms (2018)
Working Paper: A Primer on Capacity Mechanisms (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:cam:camdae:1814

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