The introduction of competition in the generation of electricity has raised the fundamental question of whether markets provide the right incentives for the provision of the capacity needed to maintain system reliability. Capacity mechanisms are adopted around the world to guarantee appropriate level of investment in electricity generation capacity.
In the first essay, we discuss these approaches and analyze the capacity pricing mechanisms from the adequacy perspective. We show that by compensating capacity, energy price is equal to the marginal cost and social welfare increases. We also find that consumers, paying capacity compensation at progressive rate on capacity, are better off than suppliers and there are cases where social welfare under the progressive rate on capacity is higher than that under the degressive rate when electricity markets are close to Cournot competition.
Since the 1990s, an increasing number of countries have implemented wholesale electricity markets. In spite of some apparent successes, a few fundamental problems remain. One of the pending policy problems is suppliers’ market power. There are a number of empirical studies aimed at researching the market power in wholesale power markets. Particularly, empirical evidence of strategic capacity withholding in wholesale electricity markets has been exhibited by several studies in Australia, England and Wales, and California.
The second essay is an analytical investigation of the capacity withholding incentives in electricity markets. We confirm that whether suppliers’ capacity withholding incentive increases or decreases in the face of increasing demand uncertainty depends on the characteristics of the demand: the ratio of the minimum demand to the maximum demand. We show that when the ratio is at a medium level, the capacity withholding incentive is more pronounced. We show that increasing the minimum demand could be more effective than decreasing the maximum demand in preventing...