Comparing Capacity Market and Payment Designs for Ensuring Supply Adequacy

Abstract

Capacity payments and capacity markets are one mechanism for ensuring that sufficient marginal generation is built to meet peak demands with an adequate reserve margin. The European Union experience with such mechanisms has focused on capacity payment mechanisms, while in the United States the trend has been towards quantity-based mechanisms, especially in the form of locationally-specific, centralized procurement auctions on a forward basis, with the grid operator securing capacity commitments three or four years ahead and allocating costs based on realized peak load. Historically, many of the European and U.S. capacity market designs have been generally ineffectual. Recent American designs have evolved towards contractual mechanisms that guarantee adequate generation investment but at potentially higher costs.