An advanced reliability reserve incentivizes flexibility investments while safeguarding the electricity market

TL;DR

This paper compares capacity markets and an advanced reliability reserve in Germany's power sector, showing the reserve promotes demand-side flexibility investments without increasing costs or compromising supply security.

Contribution

It demonstrates that an advanced reliability reserve encourages flexibility investments more effectively than capacity markets, with similar costs and security levels.

Findings

Capacity markets limit peak prices and reduce flexibility incentives.

Advanced reliability reserve boosts demand-side flexibility investments.

Both approaches maintain comparable supply security and costs.

Abstract

To ensure security of supply in the power sector, many countries are already using or discussing the introduction of capacity mechanisms. Two main types of such mechanisms include capacity markets and capacity reserves. Simultaneously, the expansion of variable renewable energy sources increases the need for power sector flexibility, for which there are promising yet often under-utilized options on the demand side. In this paper, we analyze how a centralized capacity market and an advanced reliability reserve with a moderately high activation price affect investments in demand-side flexibility technologies. We do so for a German case study of 2030, using an open-source capacity expansion model and incorporating detailed demand-side flexibility potentials across industry, process heat, and district heating. We show that a centralized capacity market effectively caps peak prices in the wholesale electricity market and thus reduces incentives for investments in demand-side flexibility options. The advanced reliability reserve induces substantially higher flexibility investments while leading to similar overall electricity supply costs and ensuring a similar level of security of supply. The advanced reliability reserve could thus create a learning environment for flexibility technologies to support the transition to climate neutral energy systems. Additionally, an advanced reliability reserve could be introduced faster and is more flexible than a centralized capacity market. While concrete design parameters are yet to be specified, we argue that policymakers should consider the reliability reserve concept in upcoming decision on capacity mechanisms in Germany and beyond.