Asymmetric risk and fuel neutrality in electricity capacity markets

Abstract

This paper calls into question the fuel neutrality of capacity mechanisms implemented in liberalized electricity markets. The argument relies on two assumptions likely satisfied in practice, first that investors are risk averse and second that markets in risk are incomplete. For the analysis, we develop a heuristic algorithm to solve large-scale stochastic equilibrium models describing a competitive market with incomplete risk trading. Introduction of a capacity mechanism has an asymmetric effect on the risk profile of different generation technologies, tilting the resource mix toward those with lower fixed costs and higher operating costs. One implication of this result is that current market structures may be ill-suited to financing low-carbon resources, the most scalable of which have high fixed costs and near-zero operating costs. Development of new risk trading mechanisms to replace or complement current capacity obligations could lead to more efficient outcomes.

Keywords: equilibrium, market design, power systems, resource adequacy, risk trading