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 overall 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 of imperfect competition (Joskow and Tirole 2007, Creti and Fabra 2007, Schwenen 2014)
Capacity reserves in a multinational market August 23 2016 Background • 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 EUR/MWh 2000 X Scarcity rent 1000 145 Demand bids Selling bids MWh
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 • otherwise ( 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 optimum
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 of the overall market level?
Capacity reserves in a multinational market August 23 2016 QUESTIONS?
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