Optimal Capacity Mechanisms for Competitive Electricity Markets

Pär Holmberg and Robert A. Ritz
Authors registered in the RePEc Author Service: Robert A. Ritz and Pär Holmberg

The Energy Journal, 2020, vol. Volume 41, issue Special Issue

Abstract: Capacity mechanisms are increasingly used in electricity market design around the world yet their role remains hotly debated. This paper introduces a new benchmark model of a capacity mechanism in a competitive electricity market with many different conventional 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. Our analysis yields a rationale for a capacity mechanism based on the internalization of a system-cost externalityýeven where the price cap is set at the value of lost load. In extensions, (i) we show how increasing variable renewables penetration can enhance the need for a capacity payment under a novel condition called "imperfect system substitutability" , and (ii) we outline the socially-optimal design of a strategic reserve with a targeted capacity payment.

JEL-codes: F0 (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (9)

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Journal Article: Optimal Capacity Mechanisms for Competitive Electricity Markets (2021)
Journal Article: Optimal Capacity Mechanisms for Competitive Electricity Markets (2020)
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