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Capacity Market Fundamentals

2013; International Association for Energy Economics; Volume: 2; Issue: 2 Linguagem: Inglês

10.5547/2160-5890.2.2.2

2160-5890

Peter Cramton, Axel Ockenfels, Steven Stoft,

Optimal Power Flow Distribution

Electricity capacity markets work in tandem with electricity energy markets to ensure that investors build adequate capacity, in line with consumer preferences for reliability.The need for a capacity market stems from several market failures.One particularly notorious problem of electricity markets is low demand flexibility.Most customers are unaware of the real time prices of electricity, have no reason to respond to them, or cannot respond quickly to them, leading to highly price-inelastic demand.This contributes to blackouts in times of scarcity and to the inability of the market to determine the marketclearing prices needed to attract an efficient level and mix of generation capacity.Moreover, the problems caused by this market failure can result in considerable price volatility and market power that would be insignificant if the demand-side of the market were fully functional.Capacity markets are a means to ensure resource adequacy while mitigating other problems due to the demand side flaws.Our paper describes the basic economics behind the adequacy problem and addresses important challenges and misunderstandings in the process of actually designing capacity markets. The adequacy problem and why electricity markets cannot solve it efficientlySuppose electricity markets did not suffer from demand-side flaws.In particular, suppose demand is sufficiently responsive to prices, such that the wholesale electricity market always clears.Then, the market would be perfectly reliable: If supply is scarce, the price would rise until there is enough voluntary load reduction to absorb the scarcity.Consumers would never suffer involuntary rationing. 2 Yet, current electricity markets do not reflect this textbook ideal of guaranteed market clearing.The main problem is a lack of real time meters and billing and other equipment to allow consumers to see and respond to real time prices, resulting in low demand flexibility. 3 Because storage of electricity is costly, the supply side is also inelastic as capacity becomes scarce.(Capacity includes both generation and equivalent demand response, but for convenience we will often refer simply to generation.)As a result, there is a possibility of non-price rationing of demand in the form of a rolling blackout, as 1 This paper builds on earlier work, which often provides much expanded discussions and derivations, including Cramton and Stoft (2005, 2006, 2008, 2010), Joskow (2007, 2008), Joskow and Tirole (2006,2007), Stoft (2002), Ockenfels (2007a, 2008a, 2008b), Cramton and Ockenfels (2012), as well as on our various practical experiences in designing capacity, reserve and other energy markets.Ockenfels thanks the German Science Foundation for support through the Leibniz program and the research unit "Design & Behavior" (FOR 1371). 2 This hypothetical case assumes automatic instantaneous demand response when needed and ignores transmission failures. 3See Joskow (2006, 2007) and Joskow and Wolfram (2012), and the references therein, for details. 4 Capacity markets generally encourage the development of demand-side resources, but even with this encouragement it appears that adequacy concerns will continue to play a significant role in electricity markets for quite some time to come. 5 We can ignore fuel costs because they are negligible compared with the rental cost of capital for a generator that runs only four or five hours a year.Also, observe that this formula does not involve the amount of unserved load, only the duration of blackouts.