Scandinavian Working Papers in Economics

Working Paper Series,
Research Institute of Industrial Economics

No 1292: Capacity Mechanisms and the Technology Mix in Competitive Electricity Markets

Pär Holmberg () and Robert A. Ritz ()
Additional contact information
Pär Holmberg: Research Institute of Industrial Economics (IFN), Postal: Stockholm, Sweden, Policy Research Group (EPRG), University of Cambridge, and Program on Energy and Sustainable Development (PESD), Stanford University
Robert A. Ritz: Energy Policy Research Group (EPRG), Judge Business School, 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

JEL-codes: D41; L94

31 pages, July 1, 2019

Full text files

wp1292.pdf PDF-file Full text

Download statistics

Questions (including download problems) about the papers in this series should be directed to Elisabeth Gustafsson ()
Report other problems with accessing this service to Sune Karlsson ().

This page generated on 2020-02-16 18:56:33.