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Assessing dynamic effects of capacity remuneration mechanisms on generation investment: comparison between strategic reserve mechanism and capacity market

Listopad 2014

14th IAEE European Energy Conference


This presentation deals with the dynamic aspects of generation investments and in particular how the capacity remuneration mechanisms considered in Europe or in the US can affect this dynamic.

Indeed, the current power markets seem to be prone to a phenomenon of investments cycles, i.e. they can experience phases of overcapacity followed by phases of under capacity. It is prejudicial for the society since the social welfare is reduced. To solve this adequacy issue and to provide optimal investments, new mechanisms, called capacity remuneration mechanisms (CRM) have been implemented (or will be), e.g. the capacity market in France, the strategic reserve mechanism in Belgium.

The purpose of this presentation is to assess the dynamic effects of two different CRMs, namely the capacity market and the strategic reserve mechanism, and to study to what extent they can correct the cyclical tendencies and the investments issues prone to happen in the current energy markets. Moreover, these two mechanisms are compared based on social welfare, which is evaluated thanks to generation costs and shortages costs.

A model, based on systems dynamics programming, has been developed to simulate functioning of both CRMs and to model investment decisions. Comparisons are made regarding two indicators, the efficiency (i.e. the costs of the mechanism) and the effectiveness (i.e. its ability to reduce shortages).

The results highlight the benefits of deploying capacity remuneration mechanisms to reduce the cyclical tendencies which are prone to appear in the energy-only market. Moreover, from the comparisons, the capacity market appears to be more beneficial than the strategic reserve mechanism from the economic point of view, since it experiences less shortages and the generation costs are lower. These comparisons based on social welfare can be used by electricity market designers (in particular from a European point of view, considering state aids issues) to determine which capacity remuneration mechanisms to adopt.

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