Supply security and short-run capacity markets for electricity

Abstract

The creation of electricity markets has raised the fundamental question as to whether markets create the right incentives for the provision of the reserves needed to maintain supply security in the short-run, or whether some form of regulation is required. In some states in the US, electricity distributors have been made responsible for providing such reserves by contracting capacity in excess of their forecasted peak demand. The so-called Installed Capacity Markets provide one means of contracting reserves, and are the subject of this paper. Under monopoly as well as under perfect competition, we identify firms' short-run opportunity costs of committing resources in the capacity market and the costs of inducing full capacity commitment. The long-run investment problem is not considered. From a welfare viewpoint, we also compare the desirability of providing reserves either through capacity markets or through the demand side (i.e. power curtailments). At the optimum, capacity obligations equal peak demand (plus expected outages) and the capacity deficiency rate (which serves as a price cap) is set at firms' opportunity costs of providing full capacity commitment.

Pricing and capacity provision in electricity markets: an experimental study

“…Joskow and Tirole (2007) show how binding price caps together with capacity obligations can restore investment incentives. Creti and Fabra (2007) show that the competitive effect of capacity markets depends on the opportunity costs of committing to capacity resources when producers have the option to export their electricity. Cramton et al (2013) provide an overview on the workings of capacity markets and argue why capacity markets are needed when demand is inelastic.…”

Assessing Energy Security in a Low-Carbon Context: The Case of Electricity in the UK

“…Chaudry et al 2011;Creti and Fabra 2007;Jamasb and Pollitt 2008;Ofgem 2011;Paulus et al 2011); these perspectives are usually rooted in physical science disciplines such as engineering (Cherp and Jewell 2011). It is worth emphasising that these perspectives are not mutually exclusive, and that there are sometimes overlaps between the fields of literature in which they are discussed; nevertheless, this broad differentiation provides a useful basis for the exploration of energy security which explicitly takes timescales of reference into account.…”

“…Electricity is difficult and costly to store, meaning that electricity markets are unique in that they require constant and instantaneous balancing of supply and demand (Creti and Fabra 2007;IEA 2004;Roscoe and Ault 2010). This means that electricity security needs to be thought of in terms of different timescales: supply and demand must be balanced over very short timescales to ensure that the electricity is immediately available when and where it is required, as well as securing sufficient overall supplies when averaged over the longer-term (Bolton and Hawkes 2013;REKK 2009).…”

“…the ability of the system to deal with disturbances such as unexpected spikes in demand or sudden losses of supply (IEA 2004;Nedic et al 2005). As well as this, the system must also be able to attract sufficient longer-term investment to ensure that there will be adequate generation, transmission and distribution capacity in the future (Bolton and Hawkes 2013;Creti and Fabra 2007).…”

Market design for generation adequacy: Healing causes rather than symptoms

“…Another issue is the compatibility of ICAP markets with interconnected markets (de Vries, 2004). Creti and Fabra (2007) show that if neighbours set the ICAP at different levels then the country with the lower cap will subsidise reserves for the country with the higher cap. Any payments for availability in one market must therefore be associated with adequate penalties for non-delivery if called, to reduce the temptation to sell the output of that capacity into another market.…”