Asymmetric Risk and Fuel Neutrality in Capacity Markets

27 Pages Posted: 8 Feb 2019

See all articles by Jacob Mays

Jacob Mays

Northwestern University

David Morton

Northwestern University - Department of Industrial Engineering and Management Sciences

Richard P. O'Neill

Government of the United States of America - Office of Economic Policy

Date Written: February 8, 2019

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

Suggested Citation

Mays, Jacob and Morton, David and O'Neill, Richard P., Asymmetric Risk and Fuel Neutrality in Capacity Markets (February 8, 2019). USAEE Working Paper No. 19-385. Available at SSRN: https://ssrn.com/abstract=3330932 or http://dx.doi.org/10.2139/ssrn.3330932

Jacob Mays (Contact Author)

Northwestern University ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

David Morton

Northwestern University - Department of Industrial Engineering and Management Sciences ( email )

2145 Sheridan Road
Room C210
Evanston, IL 60208
United States

Richard P. O'Neill

Government of the United States of America - Office of Economic Policy ( email )

888 First St., N.E.
Washington, DC 20426
United States
202 208-2220 (Phone)
202 208-0193 (Fax)

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