Template-Type: ReDIF-Article 1.0
Author-Name:  Pär Holmberg and Robert A. Ritz
Title:  Optimal Capacity Mechanisms for Competitive Electricity Markets
Classification-JEL: F0
Volume:  Volume 41
Issue:  Special Issue
Year:  2020
Abstract:  Capacity mechanisms are increasingly used in electricity market design around the world yet their role remains hotly debated. This paper introduces a new benchmark model of a capacity mechanism in a competitive electricity market with many different conventional 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. Our analysis yields a rationale for a capacity mechanism based on the internalization of a system-cost externalityýeven where the price cap is set at the value of lost load. In extensions, (i) we show how increasing variable renewables penetration can enhance the need for a capacity payment under a novel condition called "imperfect system substitutability" , and (ii) we outline the socially-optimal design of a strategic reserve with a targeted capacity payment.
Handle: RePEc:aen:journl:ej41-si1-Holmberg
File-URL: http://www.iaee.org/en/publications/ejarticle.aspx?id=3677
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