What do Models tell us About Capacity Remuneration Mechanisms?

Abstract

Capacity remuneration mechanisms (CRMs) are designed to improve investment incentives primarily through reducing revenue uncertainty. Replacing, partially or totally, the scarcity rent by a fixed annual capacity remuneration stabilizes revenues and mechanically lowers the risk premium required by investors. Numerous studies using numerical or analytical models compare the performance of systems with CRM to alternative market designs. The diversity of methods and results makes it difficult for non specialists to have a comprehensive view on CRMs efficiency. This analysis attempts to synthesize the current literature to assess whether the results of a panel of 23 papers indicate an improvement in investment conditions with capacity remuneration. The efficiency of market designs is assessed through the mainstream concerns in the literature: security of supply, welfare, price volatility and investment cycles performances. Our effort highlights the difficulty of capturing the issue of CRMs in a single unifying framework. The 23 studies analyzed do not converge towards one simple conclusion. Surprisingly, modeling decisions have little impact on results. Most studies in our panel agree on the efficiency of CRMs to reduce both price volatility and investment cycles compared to the energy only market. With respect to security of supply (SoS) and consumer surplus, the effects are overall beneficial although less consensual, mainly due to heterogeneous definition of SoS and surplus. With this respect, a more systematic effort of the research community to develop a common approach and language would certainly help advancing our understanding of CRMs further and send clearer signals to power systems regulators.