 The capacity market debate: What is the underlying market failure?Darryl R. Biggar and Mohammad Reza Hesamzadeh Utilities Policy, 2025, vol. 95, issue C Abstract: Investment in liberalized wholesale electricity markets is typically not driven by spot and forward wholesale energy price signals alone. Instead, in most wholesale electricity markets there is a separate mechanism to procure, fund or subsidize investment in generation or demand response capacity. These mechanisms are known as capacity markets and are often highly controversial. There remains substantial debate over whether these mechanisms are necessary and, if so, how they should be designed. This paper provides a theoretical analysis of the capacity market debate. We observe that an intuitive understanding of the effects of capacity mechanisms may be misleading. While a capacity mechanism may offset the effects of a price cap, if the price cap is funded through a levy on consumption the combined effect of the tax and subsidy is to nullify the price cap. We explore possible reasons for under-investment concerns in wholesale electricity markets, focusing on the potential for a lack of liquidity in the hedge market arising from the presence of uninsurable risks. We identify three groups of uninsurable risks and propose policies to address them. Keywords: Capacity market; Market failure; Uninsurable risk (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:juipol:v:95:y:2025:i:c:s0957178725000414 DOI: 10.1016/j.jup.2025.101926 Access Statistics for this article Utilities Policy is currently edited by Beecher, Janice More articles in Utilities Policy from Elsevier |
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