An Advanced Reliability Reserve Incentivizes Flexibility Investments while Safeguarding the Electricity Market

Franziska Klaucke, Karsten Neuhoff, Alexander Roth, Wolf-Peter Schill and Leon Stolle

No 2127, Discussion Papers of DIW Berlin from DIW Berlin, German Institute for Economic Research

Abstract: To ensure security of supply in the power sector, many countries are already using or discussing the introduction of capacity mechanisms. Two main types of such mechanisms include capacity markets and capacity reserves. Simultaneously, the expansion of variable renewable energy sources increases the need for power sector flexibility, for which there are promising yet often under-utilized options on the demand side. In this paper, we analyze how a centralized capacity market and an advanced reliability reserve with a moder- ately high activation price affect investments in demand-side flexibility technologies. We do so for a German case study of 2030, using an open-source capacity expansion model and incorporating detailed demand-side flexibility potentials across industry, process heat, and district heating. We show that a centralized capacity market effectively caps peak prices in the wholesale electricity market and thus reduces incentives for investments in demand-side flexibility options. The advanced reliability reserve induces substantially higher flexibility investments while leading to similar overall electricity supply costs and ensuring a similar level of security of supply. The advanced reliability reserve could thus create a learning environment for flexibility technologies to support the transition to climate neutral energy systems. Additionally, an advanced reliability reserve could be introduced faster and is more flexible than a centralized capacity market. While concrete design parameters are yet to be specified, we argue that policymakers should consider the reliability reserve concept in upcoming decision on capacity mechanisms in Germany and beyond.

Keywords: Capacity mechanisms; strategic reserve; capacity market; power sector modeling; demand-side flexibility; demand response; security of supply (search for similar items in EconPapers)
JEL-codes: C61 D47 Q41 Q48 (search for similar items in EconPapers)
Pages: 36 p.
Date: 2025
New Economics Papers: this item is included in nep-reg
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