Capacity mechanisms and the technology mix in competitive electricity markets

Pär Holmberg and Robert Ritz

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

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)
Date: 2019-07-09
New Economics Papers: this item is included in nep-ene, nep-ind and nep-reg
Note: rar36
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:cam:camdae:1960

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