Economizing the Uneconomic: Markets for Reliable, Sustainable, and Price Efficient Electricity

Abstract

The electricity policy targets aim to provide sustainable and reliable electricity with efficient prices under uncertain demand. Any solution addressing a subset of the policy targets can affect the others. Therefore, all policy targets should be addressed simultaneously. Moreover, in the restructured electricity industry these targets must be achieved with markets and incentives. Current electricity markets do not achieve the above-stated targets efficiently, thus, there are debates about the approaches needed to achieve efficiency. These debates are centered on the use of carbon markets, capacity markets, and non-market mechanisms such as offer-caps, price-caps and market-monitoring. Whereas most of the existing studies focus on one of the targets and analyze existing solutions, we focus on implementing all of the above policy targets by adopting a design approach. We develop a framework for designing efficient auctions with constraints that results in market-based implementations of the above electricity policy targets. Our results show that all policy targets can be achieved efficiently by separate capacity and carbon markets in addition to efficient spot markets. They also highlight that all policy targets can be achieved without any offer-cap, price-cap, or market monitoring. Thus they provide clear answers to the above mentioned policy debates.

Keywords: Electricity Policy, Sustainability, Reliability, Price Efficiency, Mechanism Design, Auctions with Constraints, Carbon Market, Capacity Market, Spot Market, Budget Balance, Individual Rationality, Social Welfare Optimality

JEL Classification: Q4, D44, D82