The Economics of Electricity Markets

The Economics of Electricity Markets

Theory and Policy

The Loyola de Palacio Series on European Energy Policy

Edited by Pippo Ranci and Guido Cervigni

The Economics of Electricity Markets provides a cutting-edge analysis of the critical issues involved in the design and operation of electricity markets, as well as an assessment of alternative institutional arrangements that have either been implemented or are under discussion in Europe and the US.

Chapter 3: Generation capacity adequacy

Guido Cervigni, Andrea Commisso and Dmitri Perekhodtsev

Subjects: economics and finance, energy economics, industrial economics


In the market design discussed so far, known as an ‘energy-only’ market, generators obtain revenues (only) from selling electricity and ancillary services. In this context, persistently high electricity and ancillary service prices are relied upon to attract investment in generation capacity when the existing capacity is below the equilibrium level. Conversely, low electricity and ancillary service prices discourage capital accumulation when installed capacity is above the equilibrium level. As in most other markets, the level of installed production capacity in energy-only markets is determined by the interaction between demand and supply of the final products supplied. This differs substantially from the traditional approach, in which utilities meet reliability and resource adequacy requirements according to engineering standards regarding the acceptable hours of load shedding, based on the expected load variance and generator availability. In the energy-only design, market forces rather than engineering standards determine the installed capacity, and ultimately the level of reliability.

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