Incentivizing Investment and Reliability: A Study on Electricity Capacity Markets

TL;DR

This paper analyzes the impact of capacity markets on generator investment, system reliability, and market power, using models based on NYISO data to evaluate benefits and challenges of capacity market design.

Contribution

It introduces a novel analytical framework and models to evaluate capacity market effects on investment, reliability, and market power, with empirical insights from NYISO data.

Findings

Capacity markets incentivize investment by lower-cost generators.

They enhance reliability by preventing physical withholding at high demand.

Market power issues require tailored mitigation strategies.

Abstract

The capacity market, a marketplace to exchange available generation capacity for electricity production, provides a major revenue stream for generators and is adopted in several U.S. regions. A subject of ongoing debate, the capacity market is viewed by its proponents as a crucial mechanism to ensure system reliability, while critics highlight its drawbacks such as market distortion. Under a novel analytical framework, we rigorously evaluate the impact of the capacity market on generators' revenue and system reliability. More specifically, based on market designs at New York Independent System Operator (NYISO), we propose market equilibrium-based models to capture salient aspects of the capacity market and its interaction with the energy market. We also develop a leader-follower model to study market power. We show that the capacity market incentivizes the investment of generators with lower net cost of new entry. It also facilitates reliability by preventing significant physical withholding when the demand is relatively high. Nevertheless, the capacity market may not provide enough revenue for peaking plants. Moreover, it is susceptible to market power, which necessitates tailored market power mitigation measures depending on market dynamics. We provide further insights via large-scale experiments on data from NYISO markets.