Competitive Electricity Markets and Investment in New Generating Capacity

TLDR

Evidence from the U.S. and other countries shows that organized wholesale markets for electricity and operating reserves fail to provide adequate incentives for the proper quantity or mix of generating capacity needed for reliability, largely because spot market prices do not rise high enough when capacity is fully utilized. The study aims to discuss reforms to wholesale energy markets, including forward capacity markets and symmetrical treatment of demand response and generation, to correct market and institutional imperfections. The proposed reforms involve introducing well‑designed forward capacity markets and treating demand response and generating capacity resources symmetrically to align incentives with reliability requirements.

Abstract

Evidence from the U.S. and some other countries indicates that organized wholesale markets for electrical energy and operating reserves do not provide adequate incentives to stimulate the proper quantity or mix of generating capacity consistent with mandatory reliability criteria. A large part of the problem can be associated with the failure of wholesale spot market prices for energy and operating reserves to rise to high enough levels during periods when generating capacity is fully utilized. Reforms to wholesale energy markets, the introduction of well-design forward capacity markets, and symmetrical treatment of demand response and generating capacity resources to respond to market and institutional imperfections are discussed. This policy reform program is compatible with improving the efficiency of spot wholesale electricity markets, the continued evolution of competitive retail markets, and restores incentives for efficient investment in generating capacity consistent with operating reliability criteria applied by system operators. It also responds to investment disincentives that have been associated with volatility in wholesale energy prices, limited hedging opportunities and to concerns about regulatory opportunism.