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Risk aversion and generation adequacy in liberalised electricity markets: benefits of capacity markets

Czerwiec 2016

13th International Conference on the European Energy Market, 6th – 9th June 2016, Porto

This presentation deals with the issue of risk aversion in liberalised power markets and its impact on investments in generation capacity. Given the characteristics of investments in generation capacity (capital intensive, mostly irreversible, high sunk costs, numerous uncertainties, etc.) most investors are likely to be risk averse. This can affect the way they react to energy policies aiming at providing investment incentives, and thus distort the expected outcome of these policies. It is therefore crucial to understand the potential effects of investors’ risk aversion on their decisions in order to define adequate policies.

In this presentation, the effects of risk aversion on the performances of two specific market designs are analysed: a competitive energy-only market and a capacity market. A simulation model based on system dynamics, in which investors face an uncertain peak load, is used for this purpose. The results are discussed in terms of impact on the effectiveness and efficiency of the studied market designs. The former is defined as the ability of a market design to avoid shortages while the latter is linked to the total generation costs induced by the market design. These two indicators are used as proxies to assess the overall performance of the market designs in terms of social welfare.

When comparing the performances of the capacity market and the energy-only market, it appears that the energy-only market is significantly affected by the introduction of risk aversion whereas the capacity market displays a more robust behaviour, especially regarding effectiveness. Furthermore, the results suggest that, in presence of risk averse investors, implementing a capacity market yields even higher benefits, compared to a risk neutral situation. From a policy point of view, these results suggest that implementing a capacity market can help mitigate the effects of investors’ risk aversion.

The paper is downloadable on the IEEE website.

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