Equilibrium capacity reserves in a multinational electricity market - - PowerPoint PPT Presentation

Equilibrium capacity reserves in a multinational electricity market

• Some preliminary results

Thomas Tangerås Research Institute of Industrial Economics

SAAE 2016 Luleå August 23-24 2016

Capacity reserves in a multinational market August 23 2016

Background

• Many countries contemplate, or are in the process of, procuring

capacity reserves to address resource inadequacy problems associated with increasing shares of intermittent electricity generation

• Capacity mechanisms interfere with long-run market prices

– Insufficient incentives to invest in new capacity (missing money problem) – Insufficient incentives to reduce consumption (excessive money problem)

• Such price effects propagate through to other countries in

multinational electricity markets

• Nationally determined capacity reserves run the risk of impairing the
• verall market performance
• European Commission (2015, p.10) concerned about "divergent

national market arrangements" and seeks to ensure that "capacity mechanisms…are fully in line with existing rules and do not distort the internal energy market"

Capacity reserves in a multinational market August 23 2016

Literature

• “Energy-only" markets (customers only pay for energy consumed

and generators for energy produced) sufficient to generate desired investment (Hogan 2005, Oren 2005, Joskow 2007)

• Ideal market with perfect competition and demand price sensitive

enough to deliver some, possibly very high, market-clearing price

• Short-term demand is too inflexible always to clear the market
• Non-price rationing (curtailment, rolling blackouts) sometimes

unavoidable to maintain system stability in an energy-only market

• An appropriately designed capacity mechanism would generate the

necessary capacity reserve to mitigate the resource inadequacy problem (Cramton and Stoft 2006, Cramton et al. 2013)

• Capacity markets and rationing can play a role to alleviate problems
• f imperfect competition (Joskow and Tirole 2007, Creti and Fabra

2007, Schwenen 2014)

Capacity reserves in a multinational market August 23 2016

• Rolling blackouts very infrequent in restructured electricity markets
• Sweden has not experienced a single hour of curtailment since 1996
• The electricity price has never been close to the formal price ceiling
• Capacity reserves have been activated on a number of occasions

MWh EUR/MWh 2000 1000 X 145 Scarcity rent Demand bids Selling bids

Background

Capacity reserves in a multinational market August 23 2016

Project description

• Capacity reserves act as an insurance against rolling blackouts and

extreme price spikes (Oren 2005)

• Resource adequacy is appropriately viewed in terms of a system

that maintains a high degree of reliability without resorting to extreme price spikes to achieve system reliability

• This project analyzes capacity markets as a trade-off between

– the benefit of increased reliability and price stability against – the cost of market inefficiencies that cause distortions in consumption and capacity investment decisions – instance of moral hazard

Capacity reserves in a multinational market August 23 2016

Socially optimal capacity reserves when markets are either national or perfectly integrated

• An increase in the capacity reserve

– insures consumers against price spikes – distorts consumption decisions and market-based investment

• Both effects spill over to neighboring countries under market

integration

• A portfolio effect causes the marginal benefit of insuring consumers

to be smaller under market integration

• A cost efficiency effect of causes the marginal cost of capacity

reserves to be smaller under market integration.

• The socially optimal level of the capacity reserves can be larger or

smaller under perfect market integration compared to the situation with national markets depending on which effect dominates

Capacity reserves in a multinational market August 23 2016

Equilibrium capacity reserves under partial market integration

• Markets are perfectly integrated with probability σ and national
• therwise (σ is a measure of market integration)
• Assume that policy makers set capacity reserves non-cooperatively

to maximize domestic welfare

• An increase in the domestic capacity reserve

– creates a positive foreign externality by insuring consumers abroad against price spikes – creates a negative foreign externality by distorting consumption and market-based investment decisions abroad

• The first effect is stronger if the cost effect is stronger, thereby

causing equilibrium underinvestment relative to the social optimum

• The second effect is stronger if the portfolio effect is stronger,

thereby causing equilibrium overinvestment relative to the social

• ptimum

Capacity reserves in a multinational market August 23 2016

Centralized network investment

• The degree σ of market integration is chosen to maximize overall

welfare taking the capacity reserves as given

• Network investment and capacity reserves are strategic

complements (substitutes) if the cost (cost) effect dominates

• Network investment is unambiguously downward distorted relative

to the social optimum when the choice of capacity reserves is decentralized to the country level

Capacity reserves in a multinational market August 23 2016

Renewable investment

• Less market-based investment because of a smaller average

electricity price (missing money problem)

• The effect on renewable invesmtent is ambiguous dpending on how

the support system interacts with market prices

– Green certificates can be expected to increase renewable investment – Feed-in tariffs can be expected to reduce renewable investment or to have no effect

Capacity reserves in a multinational market August 23 2016

Summary

• The equilibrium (and socially optimal) capacity reserves strike a

balance between

– insuring consumers against blackouts and price spikes – distorting consumption and investment decisions

• Both effects spill over to foreign countries under market integration
• Decentralized decision making distorts capacity reserves

– downwards if a cost efficiency effect of market integration is strong – upwards if a portfolio effect of market integration is strong

• Network investment is unambiguously downward distorted even if

chosen so as to maximize total welfare

• The distortions associated with a decentralized choice of capacity

reserves is smaller if countries are symmetric, highly integrated and capacity reserves are allocated in a cost efficient manner

Capacity reserves in a multinational market August 23 2016

Extensions

Capacity reserves insure consumers against price spikes

• 1. What if there was a financial market for hedging financial risk?

Investments in network reliability are taken at the central level to maximize total welfare across all countries

• 2. What if both network investment and capacity reserves were

decentralized to the country level? All available capacity reserves are dispatched in an efficient manner at home and abroad in situations of scarcity

• 3. What if resource inadequacy was determined at the national instead
• f the overall market level?

Capacity reserves in a multinational market August 23 2016

QUESTIONS?