A PRINCIPAL–AGENT APPROACH TO CAPACITY REMUNERATION MECHANISMS

Clémence Alasseur (), Heythem Farhat and Marcelo Saguan ()
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Clémence Alasseur: EDF R&D, FIME — Finance for Energy Markets Research Center, Paris
Heythem Farhat: #x2020;Centre de Mathámatiques Appliquées, Ecole Polytechnique, IP Paris
Marcelo Saguan: EDF R&D, FIME — Finance for Energy Markets Research Center, Paris

International Journal of Theoretical and Applied Finance (IJTAF), 2020, vol. 23, issue 08, 1-64

Abstract: We propose to study electricity capacity remuneration mechanism design through a principal–agent approach. The principal represents the aggregation of electricity consumers (or a representative entity), subject to the physical risk of shortage, and the agent represents the electricity capacity owners, who invest in capacity and produce electricity to satisfy the demand of consumers, and are subject to financial risks. Following the methodology of [J. Cvitanić, D. Possamaï & N. Touzi (2018) Dynamic programming approach to principal–agent problems, Finance and Stochastics 22(1), 1–37], we propose an optimal contract, from the perspective of consumers, which complements the revenue capacity owners achieved from the spot energy market, and incentivizes both parties to perform an optimal level of investment while sharing the physical and financial risks. Numerical results provide insights on the necessity of a capacity remuneration mechanism and also show how this is especially true when the level of uncertainties on demand or production side increases.

Keywords: Capacities market; capacity remuneration mechanism; principal–agent problem; contract theory (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1142/S0219024920500521

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