Orchestrating Investment in an Evolving Power Sector

Abstract

There is increasing concern that energy-only markets are inadequate when it comes to ensuring generation adequacy in the power sector over the long term. This is reflected in the fact that several Independent System Operators have commissioned studies about security of supply over the last few years; OFGEM and CEER (Council of European Energy Regulators) are some of them. There is some empirical evidence and substantial theory as to why incentives for investments are insufficient in such markets. Capacity mechanisms are policy tools that aim at providing incentive to this investment into reliability – both over the long-term and short-term. Compounding this inadequacy of energy-only markets is the expected change in the composition of the generating portfolio over the coming decades. It is expected that the European electricity industry is almost entirely carbon free by 2050. In addition, implementation of a capacity market in a country in hugely interconnected Europe might show cross border effects that need further insight and understanding. The purpose of this work is to evaluate the effectiveness of capacity markets, a type of capacity mechanism, in its ability to ensure long term generation adequacy, and more generally, improve the performance of the electricity sector and increase consumer and producer welfare. The effectiveness of capacity markets are assessed primarily on the following indicators: performance of the electricity market (adequacy of supply, stable energy prices), consumer welfare and producer welfare. This work is part of a larger project at the Energy and Industry section of TPM, EMLab Generation, which is focused on studying the electricity market in transition towards a low-carbon regime. The methodology applied to carry out this research is agent based modelling. A model of the capacity market has been built and analysed. In order to conceptualize a capacity market model, a thorough literature review and empirical study was carried out on the existing variations of capacity markets that are implemented across the world. While there are slight variations between them, the overarching principle beind them remains the same - to administratively place an obligation on the load to buy supply to meet a certain reserve margin of generation. The New York ISO Installed Capacity (NYISO ICAP) market was used as the primary basis to conceptualize the capacity market. The NYISO ICAP was chosen due to its relatively simple design (there are no forward capacity requirements), and well-established nature. The conceptualization was then adapted to the existing EMLab model. From this conceptual model a pseudo code for the formal model was created, and then implemented in the software. After a lengthy process of verification, the experimental set-up was designed to reflect 1. a sensitivity analysis to capacity market design parameters such as price cap and slope. 2. the effect of a capacity market in a single country, with and without target investment in renewable energy 3. the effect of a capacity market in a two country scenario, with one of the countries having an energy-only market, also with and without target investment in renewable energy. The insights from the model are mainly that the capacity market works as intended, improves the performance of the electricity sector in general, affects the adequacy and therefore the stability of the power system, affects the type of generation portfolio that might arise as a result. Specifically, On Capacity Market Design - The performance of the electricity market is highly sensitive to the price cap and slope of the capacity market. To ensure the desired level of adequacy in the system, the price cap in the capacity market must be sufficiently high (1.5 times CONE) to incentivize and induce investment. If a low price cap (say, CONE) is implemented, there could still be sufficient investment signal if the demand curve is relatively flat. A vertical demand curve is detrimental to the electricity market in general, because staggered revenues from the capacity market hugely increase the volatility in the system, reducing consumer benefit, leading even to negative profits (on an average) for producers. On Cross Border Effects of Capacity Market - The capacity market ensures the desired reserve margin in the country where it has been implemented. However it does so at a higher cost to the consumers of that country. The reasoning behind this is explained in the previous chapter. Interestingly, the model suggests that, without export constraints, between the two countries involved, the surplus capacity in the country with the capacity market dampens investment in the neighbouring country with an energy only market. This even leads to a marginally higher chance of outages in the neighbouring country. On Performance of the Capacity Market with Substantial Renewable Energy - Simulations suggest that reserve margins may need to be increased if the same level of reliability were to be maintained in a scenario with substantial renewable energy generation. Although the choice of capacity mechanism is highly dependant on the context, this work does not intend to recommend capacity market as the solution for problems with the energy only market. However, this research provides valuable insight into capacity market design, on the effects if the capacity market on producers and consumers, and in other relevant scenarios as described above.