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The electricity generation adequacy problem: Assessing dynamic effects of capacity remuneration mechanisms

January 2016

Energy Policy 91 (2016) 113–127

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

Indeed, current energy markets can exhibit a phenomenon of investment cycles, which generate phases of under and over-capacity, and hence additional costs and risks for generation adequacy. To solve this adequacy issue and to provide optimal investments, new mechanisms, called capacity remuneration mechanisms (CRM) have been implemented (or will be), in particular the capacity market (e.g. in France or in Great-Britain) and the strategic reserve mechanism (e.g. in Sweden or in Belgium).

The purpose of this paper is to assess the dynamic effects of these two different CRMs 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 simulation model, based on systems dynamics, has been developed to study the 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 solve the adequacy issue: shortages are strongly reduced compared to an 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 fewer shortages and generation costs are lower. These comparisons based on social welfare can be used by electricity market designers (in particular in Europe) to determine which capacity remuneration mechanisms to adopt.

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