Dr Serena Hesmondhaigh, The Brattle Group Ltd
We review a range of alternative wholesale electricity market designs in the context of the challenges of ensuring generation resource adequacy in a low carbon economy. Through this analysis, we identify “market mechanisms” that are compatible with government or regulatory constraints related to the shares of conventional and renewable energy of different kinds. The paper draws on research about markets around the world and derives conclusions for the GB electricity market.
We examine six alternative market designs, from energy-only markets to designs that rely on administratively-determined capacity payments or explicit reserve requirements in possible combination with centralized capacity markets. For each of these market designs, we summarize relevant international experience and discuss the advantages and disadvantages of the various approaches.
Each of these designs has advantages in certain market and regulatory environments. Some market designs have existed long enough that we are able to evaluate some of their successes and failures. More often, the market designs are still relatively new and rapidly evolving. Nevertheless, the experience to date provides some indication of how well these market designs will likely function over time.
An important question is whether and how these market designs can support (and co-exist with) government driven policy choices. In some cases, the approach is to impose out-of-market mechanisms, which is a step back in the effort to create competitive conditions in restructured power markets. These out-of-market mechanisms include payments under reliability must-run contracts, direct or indirect government investments in generating capacity and backstop mechanisms based on regulated cost recovery. Such interventions may be attractive to policy makers because they allow them to maintain reliability, or to achieve environmental objectives, when the market has otherwise failed to attract the required amount and mix of capacity.
However, these out-of-market mechanisms tend to suppress market price signals and create market distortions, which perpetuate and accelerate the need to expand the scope of out-of-market solutions. Our paper examines some of the “market mechanisms” that governments and system operators have at their disposal in order to achieve their multiple objectives, especially those related to the building of renewable capacity.