Generation Capacity Investments in Electricity Markets

Perfect Competition

G. Gürkan, O. Ozdemir, Y. Smeers

Research output: Working paperDiscussion paperOther research output

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Abstract

Abstract: In competitive electricity markets, markets designs based on power exchanges where supply bidding (barring demand-side bidding) is at the sole short run marginal cost may not guarantee resource adequacy. As alternative ways to remedy the resource adequacy problem, we focus on three different market designs in detail when demand is inelastic, namely an energy-only market with VOLL pricing (or a price cap), an additional capacity market, and operating-reserve pricing. We also discuss demand-side bidding (i.e., a price responsive demand) which can be seen as a categorically different alternative to remedy the resource adequacy problem. We consider a perfectly competitive market consisting of three types of agents: generators, a transmission system operator, and consumers; all agents are assumed to have no market power. For each market design, we model and analyze capacity investment choices of firms using a two-stage game where generation capacities are installed in the first stage and generation takes place in future spot markets at the second stage. When future spot market conditions are assumed to be known a priori (i.e., deterministic demand case), we show that all of these two-stage models with different market mechanisms, except operating-reserve pricing, can be cast as single optimization problems. When future spot market conditions are not known in advance (i.e., under demand uncertainty), we essentially have a two-stage stochastic game. Interestingly, an equilibrium point of this stochastic game can be found by solving a two-stage stochastic program, in case of all of the market mechanisms except operating-reserve pricing. In case of operatingreserve pricing, while the formulation of an equivalent deterministic or stochastic optimization problem is possible when operating-reserves are based on observed demand, this simplicity is lost when operatingreserves are based on installed capacities. We generalize these results for other uncertain parameters in spot markets such as fuel costs and transmission capacities. Finally, we illustrate how all these models can be numerically tackled and present numerical experiments. In our numerical experiments, we observe that uncertainty of demand leads to higher total generation capacity expansion and a broader mix of technologies compared to the investment decisions assuming average demand levels. Furthermore for the same VOLL (or price cap) level and under the assumptions of random demand with finite support and no forced outages, energy-onlymarkets with VOLL pricing tend to lead to total generation capacity below the peak load with a certain probability whereas energy markets with a forward capacity market or operating-reserve pricing result in higher investments. Finally, the regulator decisions (e.g., reserve capacity target) in capacity markets and operating-reserve pricing can be chosen in such a way that results in very similar investment levels and fuel mix of generation capacities in b
Original languageEnglish
Place of PublicationTilburg
PublisherEconometrics
Number of pages60
Volume2013-045
Publication statusPublished - 2013

Publication series

NameCentER Discussion Paper
Volume2013-045

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Electricity market
Perfect competition
Capacity investment
Pricing
Spot market
Adequacy
Resources
Bidding
Market design
Market mechanism
Remedies
Price caps
Numerical experiment
Optimization problem
Energy market
Stochastic games
Market conditions
Market power
Uncertainty
Generator

Cite this

Gürkan, G., Ozdemir, O., & Smeers, Y. (2013). Generation Capacity Investments in Electricity Markets: Perfect Competition. (CentER Discussion Paper; Vol. 2013-045). Tilburg: Econometrics.
Gürkan, G. ; Ozdemir, O. ; Smeers, Y. / Generation Capacity Investments in Electricity Markets : Perfect Competition. Tilburg : Econometrics, 2013. (CentER Discussion Paper).
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Gürkan, G, Ozdemir, O & Smeers, Y 2013 'Generation Capacity Investments in Electricity Markets: Perfect Competition' CentER Discussion Paper, vol. 2013-045, Econometrics, Tilburg.

Generation Capacity Investments in Electricity Markets : Perfect Competition. / Gürkan, G.; Ozdemir, O.; Smeers, Y.

Tilburg : Econometrics, 2013. (CentER Discussion Paper; Vol. 2013-045).

Research output: Working paperDiscussion paperOther research output

TY - UNPB

T1 - Generation Capacity Investments in Electricity Markets

T2 - Perfect Competition

AU - Gürkan, G.

AU - Ozdemir, O.

AU - Smeers, Y.

N1 - Pagination: 60

PY - 2013

Y1 - 2013

N2 - Abstract: In competitive electricity markets, markets designs based on power exchanges where supply bidding (barring demand-side bidding) is at the sole short run marginal cost may not guarantee resource adequacy. As alternative ways to remedy the resource adequacy problem, we focus on three different market designs in detail when demand is inelastic, namely an energy-only market with VOLL pricing (or a price cap), an additional capacity market, and operating-reserve pricing. We also discuss demand-side bidding (i.e., a price responsive demand) which can be seen as a categorically different alternative to remedy the resource adequacy problem. We consider a perfectly competitive market consisting of three types of agents: generators, a transmission system operator, and consumers; all agents are assumed to have no market power. For each market design, we model and analyze capacity investment choices of firms using a two-stage game where generation capacities are installed in the first stage and generation takes place in future spot markets at the second stage. When future spot market conditions are assumed to be known a priori (i.e., deterministic demand case), we show that all of these two-stage models with different market mechanisms, except operating-reserve pricing, can be cast as single optimization problems. When future spot market conditions are not known in advance (i.e., under demand uncertainty), we essentially have a two-stage stochastic game. Interestingly, an equilibrium point of this stochastic game can be found by solving a two-stage stochastic program, in case of all of the market mechanisms except operating-reserve pricing. In case of operatingreserve pricing, while the formulation of an equivalent deterministic or stochastic optimization problem is possible when operating-reserves are based on observed demand, this simplicity is lost when operatingreserves are based on installed capacities. We generalize these results for other uncertain parameters in spot markets such as fuel costs and transmission capacities. Finally, we illustrate how all these models can be numerically tackled and present numerical experiments. In our numerical experiments, we observe that uncertainty of demand leads to higher total generation capacity expansion and a broader mix of technologies compared to the investment decisions assuming average demand levels. Furthermore for the same VOLL (or price cap) level and under the assumptions of random demand with finite support and no forced outages, energy-onlymarkets with VOLL pricing tend to lead to total generation capacity below the peak load with a certain probability whereas energy markets with a forward capacity market or operating-reserve pricing result in higher investments. Finally, the regulator decisions (e.g., reserve capacity target) in capacity markets and operating-reserve pricing can be chosen in such a way that results in very similar investment levels and fuel mix of generation capacities in b

AB - Abstract: In competitive electricity markets, markets designs based on power exchanges where supply bidding (barring demand-side bidding) is at the sole short run marginal cost may not guarantee resource adequacy. As alternative ways to remedy the resource adequacy problem, we focus on three different market designs in detail when demand is inelastic, namely an energy-only market with VOLL pricing (or a price cap), an additional capacity market, and operating-reserve pricing. We also discuss demand-side bidding (i.e., a price responsive demand) which can be seen as a categorically different alternative to remedy the resource adequacy problem. We consider a perfectly competitive market consisting of three types of agents: generators, a transmission system operator, and consumers; all agents are assumed to have no market power. For each market design, we model and analyze capacity investment choices of firms using a two-stage game where generation capacities are installed in the first stage and generation takes place in future spot markets at the second stage. When future spot market conditions are assumed to be known a priori (i.e., deterministic demand case), we show that all of these two-stage models with different market mechanisms, except operating-reserve pricing, can be cast as single optimization problems. When future spot market conditions are not known in advance (i.e., under demand uncertainty), we essentially have a two-stage stochastic game. Interestingly, an equilibrium point of this stochastic game can be found by solving a two-stage stochastic program, in case of all of the market mechanisms except operating-reserve pricing. In case of operatingreserve pricing, while the formulation of an equivalent deterministic or stochastic optimization problem is possible when operating-reserves are based on observed demand, this simplicity is lost when operatingreserves are based on installed capacities. We generalize these results for other uncertain parameters in spot markets such as fuel costs and transmission capacities. Finally, we illustrate how all these models can be numerically tackled and present numerical experiments. In our numerical experiments, we observe that uncertainty of demand leads to higher total generation capacity expansion and a broader mix of technologies compared to the investment decisions assuming average demand levels. Furthermore for the same VOLL (or price cap) level and under the assumptions of random demand with finite support and no forced outages, energy-onlymarkets with VOLL pricing tend to lead to total generation capacity below the peak load with a certain probability whereas energy markets with a forward capacity market or operating-reserve pricing result in higher investments. Finally, the regulator decisions (e.g., reserve capacity target) in capacity markets and operating-reserve pricing can be chosen in such a way that results in very similar investment levels and fuel mix of generation capacities in b

M3 - Discussion paper

VL - 2013-045

T3 - CentER Discussion Paper

BT - Generation Capacity Investments in Electricity Markets

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ER -

Gürkan G, Ozdemir O, Smeers Y. Generation Capacity Investments in Electricity Markets: Perfect Competition. Tilburg: Econometrics. 2013. (CentER Discussion Paper).