CapOptix: An Options-Framework for Capacity Market Pricing

TL;DR

CapOptix introduces a novel capacity pricing framework that models capacity commitments as financial derivatives, accounting for price risks and shifts, to improve reliability and market efficiency.

Contribution

This work presents CapOptix, a new options-based capacity market framework that incorporates regime switching to better reflect price dynamics and risk in capacity remuneration.

Findings

CapOptix's capacity premiums align with historical price data.

The framework captures structural price shifts more effectively.

Comparison shows improvements over traditional mechanisms.

Abstract

Electricity markets are under increasing pressure to maintain reliability amidst rising renewable penetration, demand variability, and occasional price shocks. Traditional capacity market designs often fall short in addressing this by relying on expected-value metrics of energy unserved, which overlook risk exposure in such systems. In this work, we present CapOptix, a capacity pricing framework that interprets capacity commitments as reliability options, i.e., financial derivatives of wholesale electricity prices. CapOptix characterizes the capacity premia charged by accounting for structural price shifts modeled by the Markov Regime Switching Process. We apply the framework to historical price data from multiple electricity markets and compare the resulting premium ranges with existing capacity remuneration mechanisms.