A Capacity Market that Makes Sense

Peter Cramton and Steven Stoft ()

Papers of Peter Cramton from University of Maryland, Department of Economics - Peter Cramton

Abstract: We argue that a capacity market is needed in most restructured electricity markets, and present a design that avoids the many problems found in the early capacity markets. The proposed locational capacity market pays suppliers based on their demonstrated ability to supply energy or reserves in shortage hours—hours in which there is a shortage of operating reserves. Thus, only supply that contributes to reliability is rewarded. The capacity price responds to market conditions. When capacity is scarce the capacity price is high; when capacity is plentiful the capacity price is low or zero. Market power in the capacity market is addressed by setting the capacity price based on actual capacity, rather than bid capacity, so generators cannot increase the capacity price by withholding supply. Ex post peak energy rents (the short-run energy profits of a benchmark peaking unit) are subtracted from the capacity price. Thus, a supplier does not have an incentive to create real-time shortages—the high shortage price resulting from a shortage is subtracted from the capacity price, so there is no net gain from the high price. By defining a capacity product closely tied to reliability and directly addressing market power both in the capacity market and in the spot energy market, the proposed design results in a market participants can trust to encourage efficient behavior both in the short run and long run.

Keywords: Auctions; Electricity Auctions; Capacity Auctions; Market Design (search for similar items in EconPapers)
JEL-codes: D44 (search for similar items in EconPapers)
Pages: 13 pages
Date: 2005, Revised 2005
New Economics Papers: this item is included in nep-com and nep-mic
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (104)

Published in Electricity Journal, 18, 43-54, August/September 2005

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