Locational Electricity Capacity Markets: Alternatives to Restore the Missing Signals

Thu Mar 01 15:24:00 EST 2007
By Hamish Fraser et al.

Given the absence of a properly functioning demand-side in electricity markets, the need for a centralized Capacity Payment Mechanism (CPM) has been widely accepted in many jurisdictions around the world. While there is no universal agreement on the best CPM design, most schemes implemented worldwide produce a uniform capacity price for an entire region or country. This lack of a locational dimension tends to exacerbate network congestion, and a number of alternatives outside the centralized CPM construct have been implemented to avoid local capacity shortfalls. However, many of these mechanisms present a number of efficiency problems. Regulators and independent system operators are still looking for capacity solutions that promote efficient co-ordination of generation and transmission investment.

In this article from the March issue of The Electricity Journal, NERA Vice President Amparo Nieto and Affiliated Consultant Hamish Fraser explore the range of traditional and innovative locational incentive mechanisms adopted in the US and abroad. They evaluate these methods from the point of view of the incentives provided to market participants and their potential impact on the efficiency in the market. The authors conclude that a well-designed CPM with built-in locational incentives holds more promise for signaling the value of capacity to potential investors than cost-based payments directed to must-run generators. Specifically, forward capacity auctions present potential additional merits over CPM methods based on bilateral contracting, as the bidding process can reveal crucial information of the opportunity cost of new resources. Notwithstanding the advantages of these innovative CPM schemes, their effectiveness is yet to be seen; the authors discuss the key areas that will need further work to increase the probability that locational CPMs succeed in restoring the missing signals.