COMPETITIVE ELECTRICITY MARKETS AND INVESTMENT IN NEW GENERATING CAPACITY

TLDR

Organized wholesale markets for electricity and operating reserves fail to provide adequate incentives for the proper quantity or mix of generating capacity, as prices do not rise high enough during full utilization. The paper proposes reforms to wholesale energy markets—including forward capacity markets and balanced treatment of demand response and generation—to address investment disincentives from price volatility, limited hedging, and regulatory opportunism. The reforms aim to improve spot market efficiency, support competitive retail markets, and restore incentives for investment in capacity that meets reliability criteria.

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.