Abstract
Capacity auctions with reliability options are seen as a promising possibility to reduce the investment risk for electricity generators as well as to set incentives for sufficient investments in generating capacity. However, there has been little attention so far on the interaction between a capacity market and an increasing share of renewable energy. In a first step we formalize the functioning of capacity auctions with reliability options. We improve their incentive regulation to allow effective incentives for sufficient investments. In a second step we study, with comparative statics, how an increasing share of renewable energy, varying carbon emission costs and the existing capacity mix influence the outcome of a capacity auction. For an increasing share of renewable energy, capacity auctions direct investments to more flexible power plants. This opposes the merit order effect of renewable energy which is observed at energy-only markets. A capacity market can therefore prevent missing flexibility feared at energy-only markets as a result of an increasing share of renewable energy.
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Notes
See Ranci and Cervigni (2013) for a detailed overview of the structure and functioning of electricity markets.
Resource adequacy denotes the system’s ability to satisfy demand at all times in contrast to security of supply which describes the ability to balance sudden changes in demand (Regulatory Commission for Electricity and Gas 2012: 7). Resource adequacy can therefore be defined as long-term security of supply.
Emission costs stem from an emissions trading scheme or carbon taxes.
For an optimal price cap MM vanishes as it is part of the PER. We nevertheless retain the differentiation in PER and MM to illustrate the functioning of a capacity market in the following analysis.
Recall that a penalty only occurs for price bids exceeding PER per capacity unit (see Sect. 3.2.1).
A detailed description of the investment algorithm is given in Bhagwat (2016).
The effect that an increasing share of renewable energy reduces the spot price level in the short run is called merit order effect (Sensfuß et al. 2008).
Recall that Fig. 1 depicts a spot market in equilibrium. Then MM corresponds to the integral over duration time from \(p_{cap}\) to infinity. This relation is no longer valid in a distorted equilibrium. Thus, MM increases for decreasing spot market rents.
Other advantages (risk reduction, reaction on an increasing share of renewable energy sources) may nevertheless justify a capacity market as we will see in the further discussion of the example.
It is also possible that the regulator commits already existing generators to a maximum bid which is equal to the PER per capacity unit.
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Schäfer, S., Altvater, L. On the functioning of a capacity market with an increasing share of renewable energy. J Regul Econ 56, 59–84 (2019). https://doi.org/10.1007/s11149-019-09389-6
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DOI: https://doi.org/10.1007/s11149-019-09389-6