Capacity Payments Research Articles

Capacity certificate mechanism: A step forward toward a market based generation capacity incentive

Theoretical studies and practical experiences in power systems show that electricity market by itself cannot create an effective mechanism for optimal investment in generation capacity expansion. This is due to some inherent characteristics of power systems, such as high investment costs, and various risks in profit and return of capital. On the other hand, the political, social, and economic consequences of shortage of power generation are intolerable in any conditions. As a result, several incentives such as capacity payment, capacity auction, capacity obligation, and strategic reserve have been introduced to support investment in generation capacity. But all these incentives suffer from a number of inadequacies and inefficiencies. In this paper, first a new incentive called Capacity Certificate is proposed and its characteristics are explained. Then, taking the advantage of System Dynamics, the impact of this mechanism on long-term performance of power market is studied from the generation capacity expansion perspective, and is compared with energy-only and capacity payment mechanisms. Indicators such as system reserve and the overall customer payments reveal the benefits of the proposed mechanism. In addition, this mechanism effectively motivates the customers to optimize their energy consumption, while none of the other incentives has such a capability.

Capacity payment allocation in hydrothermal power systems with high shares of renewable energies

The increasing use of variable generation technologies (VGTs) in power systems, such as wind and photovoltaic generation, has introduced new challenges in the definition of capacity remuneration mechanisms for promoting system reliability. In this context, in this article we propose a novel framework for determining the capacity value of VGTs to contribute to the generation system adequacy, as well as a corresponding method for allocating capacity payments in hydrothermal power systems. We show that the capacity value of VGTs increases with the presence of water reservoirs, since VGTs help relieving hydropower plants from using scarce water resources during off-peak hours thus making more resources available to supply the demand during peak hours.

Investment Incentives in Competitive Electricity Markets

This paper presents the analysis of a novel framework of study and the impact of different market design criterion for the generation expansion planning (GEP) in competitive electricity market incentives, under variable uncertainties in a single year horizon. As investment incentives conventionally consist of firm contracts and capacity payments, in this study, the electricity generation investment problem is considered from a strategic generation company (GENCO) ′ s perspective, modelled as a bi-level optimization method. The first-level includes decision steps related to investment incentives to maximize the total profit in the planning horizon. The second-level includes optimization steps focusing on maximizing social welfare when the electricity market is regulated for the current horizon. In addition, variable uncertainties, on offering and investment, are modelled using set of different scenarios. The bi-level optimization problem is then converted to a single-level problem and then represented as a mixed integer linear program (MILP) after linearization. The efficiency of the proposed framework is assessed on the MAZANDARAN regional electric company (MREC) transmission network, integral to IRAN interconnected power system for both elastic and inelastic demands. Simulations show the significance of optimizing the firm contract and the capacity payment that encourages the generation investment for peak technology and improves long-term stability of electricity markets.

Analysis of coal conversion to biomass as a transitional technology

Abstract The dominant transitional path towards a low carbon electricity industry for systems which have been heavily dependent upon coal is through its replacement by large scale wind farms and the widespread emergence of distributed solar. In this pathway, maintaining resource adequacy in the context of increased intermittency in generation has become a major concern. This paper examines this requirement to maintain resource adequacy and compare the costs and carbon impacts for new gas turbines or biomass conversions to achieve this in an expedient transitional way. This is formulated as a policy optimization in which the imperative is to replace existing coal with a renewable alternative (in this case study, wind) and to maintain the system security at the existing level, and thereby find the optimal subsidies, either as energy credits (“green certificates” or “contracts-for-differences”) or capital benefits (“capacity payments” or tax allowances). In a model of the GB system, the results show that biomass-conversion outperforms investment in peaking gas turbines to deal with the transitional economic externality of extra reserve costs. In particular, the results suggest benefits of 10% lower costs of subsidies, 70% lower implied costs of carbon, and a reduction of 18% in wholesale power prices.

A primer on capacity mechanisms

Abstract A simple model is built up to capture the key drivers of investment and pricing incentives in electricity markets. The focus is put on the interaction between market power and investment incentives, and the trade-off it introduces when designing the optimal regulatory instruments. In contrast to the energy-only market paradigm that assumes perfect competition, our model demonstrates that in the presence of market power scarcity prices do not promote efficient investments, even among risk-neutral investors. Combining price caps and capacity payments allows to disentangle the two-fold objective of inducing the right investment incentives while mitigating market power. Bundling capacity payments with financial obligations further mitigates market power as long as strike prices are set sufficiently close to marginal costs.

A primer on capacity mechanisms

A simple model is built up to capture the key drivers of investment and pricing incentives in electricity markets. The focus is put on the interaction between market power and investment incentives, and the trade-off it introduces when designing the optimal regulatory instruments. In contrast to the energy-only market paradigm that assumes perfect competition, our model demonstrates that in the presence of market power scarcity prices do not promote efficient investments, even among risk-neutral investors. Combining price caps and capacity payments allows to disentangle the two-fold objective of inducing the right investment incentives while mitigating market power. Bundling capacity payments with financial obligations further mitigates market power as long as strike prices are set sufficiently close to marginal costs.

Capacity payment mechanisms and investment incentives in restructured electricity markets

We investigate the impacts of capacity payment mechanisms on generation capacity investment and subsequent energy and capacity market competition. We analyze the optimal design of capacity demand parameters. The presence of price-responsive capacity demand reduces firms' abilities to exercise market power, alleviates the volatile bimodal capacity market pricing structure, reduces market concentration, and increases expected consumer surplus. While capacity payments expand investment, the first-best aggregate level of capacity is not achieved at the optimal capacity payment parameters. We demonstrate that the addition of subsidized renewable generation capacity puts downward pressure on energy prices. When renewable output is not sufficiently positively correlated with energy demand, renewable capacity expansion reduces the expected available production capacity and increases the probability of capacity scarcity for a given level of capacity demand parameters. Consequently, the regulator must expand capacity payments to achieve the same level of resource adequacy.

An empirical analysis of California’s hybrid capacity options

We propose a new approach to analyze the payoffs of a hybrid capacity option with a daily-varying strike price. We document that the option’s payoffs are less than the capacity payments required to attract customer participation. We also present results useful for designing payoff-neutral options to enhance customer participation in a capacityidding program. Our proposed approach is equally applicable for a transparent analysis of the payoffs of other types of exotic capacity options.

Robustness of capacity markets: a stochastic dynamic capacity investment model

We present a stochastic dynamic capacity investment model that incorporates strategic bidding of generators, price elasticity of demand, and ramping constraints. The model is based on an iterative procedure of finding an equilibrium electricity price forecast closely depicting real-world investor behavior. We assess the robustness and the total cost of generation of a capacity market compared to an energy-only market as capacity markets are increasingly considered worldwide due to market imperfections and rising feed-in from renewables. To estimate unplanned unavailabilities, we analyze a novel data set of the European Energy Exchange describing unplanned unavailability incidents. Applying the model to the Great Britain market, we find that capacity markets are more robust to unplanned unavailabilities of conventional generation in terms of the total cost of generation and price volatility. At the same time, capacity markets induce additional costs through capacity payments. Therefore, we jointly analyze the total cost of generation and the robustness with different levels of reserve margins. Our results show that there is a promising area of efficient trade-offs between costs and robustness in the range of reserve margins between 0 and 15%.

The Economic Benefits of Generation Revenue and Demand Payment Assessment in Pool-based Market Model: The Case of Malaysia

In Malaysia, as the Power Purchased Agreement is coming toward the end, pool market model is recognized as a conceivable model to overcome the shortcomings of the single buyer market. However, there are issues on the welfare of the generators involved. In context of Malaysian Electricity Supply Industry, this paper proposes a model, a pool hybrid introducing the minimum capacity payment involving the efficiency of the generators and base load sharing approaches. Under single auction power pool, a case study is conducted for the generators in Peninsular Malaysia for an economic analysis to highlight the merits of the proposed model compared with other pool-based market models in terms of generation revenue and demand payment. The load demand curves, the details of the MW-installed capacity, energy prices, capacity prices, and efficiency of the generators are the parameters taken into account in carry out analysis on each generator revenue. Results have shown that pool hybrid market ensures the intermediate value of generation revenue with all Independent Power Producers participation even at the lowest demand and decreased the demand payment.

An Economic Analysis of Opt-In/Opt-Out: Payments to FirstNet and Annual Spectrum Network Capacity Payments

FirstNet was created to establish a Nationwide Public Safety Broadband Network (NPSBN) to provide reliable, modern and interoperable communications to first responders. Every Governor has the right to “opt-out” of the FirstNet plan for his or her state and develop an alternative plan for the radio access network of his or her state. Due to the economics of the wireless industry, states with high-density and/or high-income populations are likely to generate financial surpluses from this network, while states with low-density and/or lower-income populations will likely operate at a loss. Since Congress mandated a nationwide, self-funding PSBN, network operations in “profitable” states will inevitably subsidize loss-making states. In its NPSBN solicitation, FirstNet determined that the amount necessary for its operational sustainability over 25 years was $5.625 billion. In an opt-in state, FirstNet’s contractor contributes to FirstNet via “Payments to FirstNet” only to later receive funds from FirstNet to be reinvested into the network. Specifically, AT&T will pay a nationwide total of $18 billion and receive $16 billion for reinvestments. For opt-out states, FirstNet has required “Capacity payments.” Based on a small number of publicly available data points, it seems highly likely that the opt-out states’ capacity payments are at least equal to $18 billion. Contrary to opt-in states, opt-out states are not entitled to receive reinvestment funds.

Regional disparities, absorption capacity and Structural Fund payments: A case study of the Czech Republic

Abstract The intention of this paper is to provide empirical evidence on how the factors of socio-economic disadvantage and absorption capacity influence the spatial distribution of Structural Fund (SF) payments among the Czech Republic’s micro-regions during the 2007–2013 programming period. The empirical results indicate that agglomeration economies, innovation and entrepreneurship are associated with higher SF absorption capacity and higher SF payments, challenging the tendency for socio-economically disadvantaged regions to converge. SF absorption capacity measured especially by the number of project applications submitted for SF financing and by the average SF budget per project application, is a crucial concept in order to understand the relationship between within-country regional disparities and SF interventions.

Evaluation of regulatory impacts on investments of distributed generation and upstream network under uncertainty: a new stochastic bi-level model

A new framework is proposed to study impacts of regulatory incentive policies on distributed generation (DG) investment, as well as upgrading of upstream transmission substations and sub-transmission lines. Investment incentives are fuel cost, firm contracts, capacity payments and investment subsidy. Conventional and wind generation technologies are considered as expansion candidates for investor which participate in wholesale and contractual markets. High Temperature Low Sag (HTLS) conductors are used as expansion candidates for lines. The problem is modelled as a stochastic bi-level optimization problem, where the upper-level consists of investor’s decisions maximizing its own profit, while both market clearing and decision on upgrading of substations and lines aimed at minimizing the total cost are considered in the lower-level. Due to non-convexity of lower level problem, an algorithm based on enumeration and mathematical optimization is used where for each expansion strategies of substations and lines, the bi-level problem is converted to a stochastic mathematical programming with equilibrium constraints and then converted to a mixed-integer linear program. The effectiveness of the proposed model is tested through on an actual 22-bus [The west of MAZANDARAN Regional Electric Company (MREC) sub-transmission network as an area of Iran interconnected power system.] network.

Welfare implications of capacity payments in a price-capped electricity sector: A case study of the Texas market (ERCOT)

The aim of this paper is to analyze the welfare consequences of introducing capacity compensation payments in restructured and liberalized electricity markets. For that purpose, we set up a two-stage framework in which two kinds of electricity generators, peak load and base load generators, choose their capacity investment levels first and then compete on the basis of bids in a centralized market to sell electricity to consumers. We use data from the Texas ERCOT to evaluate consumers' welfare. We find that the introduction of capacity payments has two countervailing effects. On the one hand, it increases the wholesale electricity price. On the other hand, it reduces price volatility and increases the reliability of the system. We find that capacity payments are more beneficial for consumers in a perfectly competitive market than in the presence of certain degree of market power.

Pricing and capacity provision in electricity markets: an experimental study

The creation of adequate investment incentives has been of great concern in the restructuring of the electricity sector. However, to achieve this, regulators have applied different market designs across countries and regions. In this paper we employ laboratory methods to explore the relationship between market design, capacity provision and pricing in electricity markets. Subjects act as firms, choosing their generation capacity and competing in uniform price auction markets. We compare three regulatory designs: (1) a baseline price cap system that restricts scarcity rents, (2) a price spike regime that effectively lifts these restrictions, and (3) a capacity market that directly rewards the provision of capacity. Restricting price spikes leads to underinvestment. In line with the regulatory intention both alternative designs lead to sufficient investment albeit at the cost of higher energy prices during peak periods and substantial capacity payments in the capacity market regime. To some extent these results confirm theoretical expectations. However, we also find lower than predicted spot market prices as sellers compete relatively intensely in capacities and prices, and the capacity markets are less competitive than predicted.

Inducing truthful revelation of generator reliability

Liberalised electricity markets often include a capacity remuneration mechanism to allow generation firms recover their fixed costs. Various de-rating factors and/or penalties have been incorporated into such mechanisms in order to reward the unit based on the contribution they make to system security, which in turn depends on the unit's reliability. However, this reliability is known to the firm but not to the regulator. We adopt a mechanism design approach for capacity payments based on a declaration by the firm of their reliability. The mechanism scales payments and penalties according to this declared reliability such that the firm's profit-maximising strategy is to truthfully reveal its reliability. A stochastic mixed complementarity problem (MCP) is used to model the interactions between the firms, and we apply this methodology to a test system using Irish electricity market data. Truth-telling is induced, increasing the efficiency of capacity payments while eliminating the requirement for the regulator to allocate resources to discovering reliability.

Investment vs. Refurbishment: Examining Capacity Payment Mechanisms Using Stochastic Mixed Complementarity Problems

Capacity remuneration mechanisms exist in many electricity markets. Capacity mechanism designs do not explicitly consider the effects of refurbishment of existing generation units in order to increase their reliability. This paper presents a stochastic mixed complementarity problem to examine the impact of refurbishment on electricity prices and generation investment. Capacity payments are found to increase reliability when refurbishment is not possible, while capacity payments and reliability options yield similar results when refurbishment is possible. Final costs to consumers are similar under the two mechanisms with the exception of the initial case of overcapacity.

Optimal Bidding in Performance-Based Regulation Markets: An MPEC Analysis With System Dynamics

In this paper, we address the problem of optimal bidding in performance-based regulation markets for a large price-maker regulation resource. Focusing on the case of the California Independent System Operator (ISO), detailed market components are considered, such as regulation capacity payment, regulation mileage payment, performance accuracy adjustment, automatic generation control dispatch, and participation factor. Our analysis also incorporates system dynamics of the regulation resource for different resource types and technologies. In principle, our problem formulation is a mathematical program with equilibrium constraints (MPEC). However, our fundamentally new formulations introduce several new challenges in solving the MPEC problem in the context of performance-based regulation markets that are not previously addressed. In fact, global optimization techniques fail to solve the original nonlinear program due to its complexity. Therefore, we undergo several innovative steps to transform the problem into a mixed-integer linear program which is solved with accuracy, reliability, and computational efficiency. Insightful case studies are presented using data from a California ISO regulation market project.

Do Energy Efficiency Investments Deliver at the Right Time?

Most analyses of energy efficiency investments ignore that the value of electricity varies widely across hours. We show how much timing matters. Using novel hourly consumption data from an air conditioner rebate program in California, we find that energy savings are concentrated in high-value hours. This significantly increases the value of these investments, especially after we account for the large capacity payments that electricity generators receive to guarantee supply in peak hours. We then use engineering predictions to calculate timing premiums for a wide range of energy efficiency investments, finding substantial variation in economic value across investments. (JEL L94, L98, Q41, Q48)

Price caps with capacity precommitment

We examine the effectiveness of price caps to regulate imperfectly competitive markets in which the demand is uncertain. To that effect, we study a monopoly that makes irreversible capacity investments ex-ante, and then chooses its output up to capacity upon observing the realization of demand. We show that the optimal price cap must trade off the incentives for capacity investment and capacity withholding, and is above the unit cost of capacity. Moreover, while a price cap provides incentives for capacity investment and mitigates market power, it cannot eliminate inefficiencies. Capacity payments provide a useful complementary instrument.