Capacity Mechanisms and the Technology Mix in Competitive Electricity Markets

Pär Holmberg and Robert Ritz

No 1292, Working Paper Series from Research Institute of Industrial Economics

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.

Keywords: Investment; Wholesale electricity market; Capacity mechanism; Capacity auction; Strategic reserve (search for similar items in EconPapers)
JEL-codes: D41 L94 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2019-07-01
New Economics Papers: this item is included in nep-des, nep-ene and nep-reg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Related works:
Working Paper: Capacity mechanisms and the technology mix in competitive electricity markets (2019)
Working Paper: Capacity mechanisms and the technology mix in competitive electricity markets (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:hhs:iuiwop:1292

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