Table of Contents
1 Introduction ………………………………………………………………………………… 1
1.1 Reason for this study ………………………………………………………………….. 1
1.2 Research subject ………………………………………………………………………….. 2
1.3 Social and scientific relevance ……………………………………………………….. 3
1.4 Reading guide …………………………………………………………………………….. 4
2 Research framework ……………………………………………………………….. 7
2.1 Introduction ………………………………………………………………………………… 7
2.2 Problem definition ………………………………………………………………………. 7
2.2.1 Policy goals ……………………………………………………………………………… 7
2.2.2 How it used to be …………………………………………………………………… 8
2.2.3 Definitions ……………………………………………………………………………… 9
2.2.4 Two aspects of market design ……………………………………………………. 10
2.3 Research questions ……………………………………………………………………. 12
2.4 Research scope and assumptions ……………………………………………………. 13
2.4.1 Generation adequacy …………………………………………………………… 13
2.4.2 Coordination …………………………………………………………………………. 14
2.4.3 Technical developments ……………………………………………………….. 15
2.5 Method ………………………………………………………………………………………. 17
2.5.1 Generation adequacy …………………………………………………………… 17
2.5.2 Coordination …………………………………………………………………………. 19
3 System description …………………………………………………………………… 21
3.1 Introduction ………………………………………………………………………………… 21
3.2 The electricity system ………………………………………………………………… 21
3.3 The technical subsystem ……………………………………………………………. 22
3.3.1 Components ………………………………………………………………………….. 22
3.3.2 Operation ………………………………………………………………………………. 24
3.4 The economic subsystem ………………………………………………………….. 26
3.4.1 Function and definition …………………………………………………………. 26
3.4.2 Actors ……………………………………………………………………………………. 27
3.4.3 Model ……………………………………………………………………………………. 28
3.5 Links between the two subsystems ……………………………………………………. 30
3.5.1 Links between the technical and the economic subsystem …………….. 30
3.5.2 Feedback to the technical subsystem ………………………………………… 32
3.5.3 Relevance of the model …………………………………………………………. 34
3.6 System optimization …………………………………………………………………… 34
3.6.1 In theory …………………………………………………………………………………. 34
3.6.2 The use of constraints ……………………………………………………………. 35
3.6.3 Unbundling and system optimization ………………………………………….. 36
3.6.4 Dynamic optimization …………………………………………………………… 36
4 The electricity crisis in California …………………………………………………….. 39
4.1 Introduction ………………………………………………………………………………… 39
4.2 Restructuring California’s electricity market ……………………………………… 40
4.2.1 Prelude ………………………………………………………………………………….. 40
4.2.2 The rules ………………………………………………………………………………… 40
4.2.3 The players …………………………………………………………………………….. 42
4.3 Crisis …………………………………………………………………………………………. 43
4.3.1 Chronology …………………………………………………………………………….. 43
4.3.2 Trends ……………………………………………………………………………………. 46
4.4 Analysis ……………………………………………………………………………………. 49
4.4.1 Physical crisis ………………………………………………………………………….. 49
4.4.2 Financial crisis …………………………………………………………………………. 51
4.4.3 Manipulation ………………………………………………………………………….. 53
4.5 Conclusions ………………………………………………………………………………… 54
4.6 Lessons for other electricity systems …………………………………………………… 55
5 The question of generation adequacy ……………………………………………… 57
5.1 Introduction ………………………………………………………………………………… 57
5.1.1 The question …………………………………………………………………………… 57
5.1.2 Approach ………………………………………………………………………………… 58
5.1.3 Some technical aspects of generation adequacy ……………………………. 59
5.1.4 Literature ………………………………………………………………………………… 63
5.2 Investment in a perfectly competitive market ………………………………………. 66
5.2.1 Investment incentives in theory ……………………………………………………. 66
5.2.2 Low demand price-elasticity ……………………………………………………….. 67
5.2.3 Generation capacity as a public good …………………………………………… 68
5.2.4 Value of lost load pricing: a second-best optimum ………………………… 70
5.2.5 Summary ………………………………………………………………………………… 72
5.3 Factors influencing the investment equilibrium ………………………………….. 73
5.3.1 Price restrictions ……………………………………………………………………… 74
5.3.2 Imperfect information …………………………………………………………….. 74
5.3.3 Regulatory uncertainty …………………………………………………………… 74
5.3.4 Regulatory restrictions on investment ……………………………………………. 76
5.3.5 Risk aversion …………………………………………………………………………….. 77
5.3.6 Uncertainty regarding input markets …………………………………………….. 77
5.3.7 Externalities in the generating market ……………………………………………. 78
5.3.8 Overview of the argument ……………………………………………………….. 78
5.4 Investment and risk ……………………………………………………………………… 79
5.4.1 Introduction …………………………………………………………………………….. 79
5.4.2 The optimal volume of available capacity ……………………………………… 80
5.4.3 The optimal volume of installed capacity ………………………………………. 84
5.4.4 Asymmetric risk ……………………………………………………………………… 87
5.4.5 The perspective of generating companies ……………………………………… 89
5.4.6 Summary ………………………………………………………………………………… 92
5.5 Long-term market dynamics …………………………………………………………. 93
5.5.1 Investment cycles ……………………………………………………………………… 93
5.5.2 The role of long-term contracts …………………………………………………….. 96
5.6 Market power ……………………………………………………………………………….. 98
5.6.1 Short term: withholding during a shortage ……………………………………… 98
5.6.2 Long term: strategic investment behavior ……………………………………… 99
5.7 Technological changes in the electricity sector …………………………………….. 101
5.8 Trade between electricity systems ……………………………………………………… 102
5.9 Policy choices ……………………………………………………………………………….. 103
5.10 Conclusions ………………………………………………………………………………… 104
6 Capacity mechanisms ………………………………………………………………… 107
6.1 Introduction ………………………………………………………………………………… 107
6.2 Capacity payments ……………………………………………………………………… 110
6.3 Strategic reserve ………………………………………………………………………….. 111
6.4 Operating reserves pricing …………………………………………………………… 115
6.5 Capacity requirements ………………………………………………………………. 119
6.6 Reliability contracts ………………………………………………………………………. 122
6.7 Capacity subscriptions ………………………………………………………………… 126
6.8 Overview ……………………………………………………………………………………. 129
7 Evaluation of the capacity mechanisms …………………………………………….. 131
7.1 Introduction ………………………………………………………………………………… 131
7.2 Criteria …………………………………………………………………………………………. 132
7.3 Capacity payments ……………………………………………………………………… 138
7.4 Strategic reserve ………………………………………………………………………….. 143
7.5 Operating reserves pricing …………………………………………………………… 148
7.6 Capacity requirements ………………………………………………………………. 154
7.7 Reliability contracts ……………………………………………………………………… 158
7.8 Capacity subscriptions ……………………………………………………………….. 162
7.9 Comparison ………………………………………………………………………………… 166
7.10 Conclusions ………………………………………………………………………………… 170
8 Generation adequacy in Europe ……………………………………………………….. 173
8.1 Introduction ………………………………………………………………………………… 173
8.2 Innovative capacity mechanisms ……………………………………………………… 174
8.2.1 Introduction …………………………………………………………………………….. 174
8.2.2 Reliability contracts in an open, decentralized system …………………….. 174
8.2.3 Bilateral reliability contracts ……………………………………………………….. 176
8.2.4 A financial version of capacity subscriptions ………………………………….. 179
8.2.5 Overview ……………………………………………………………………………….. 184
8.3 Policy choices ……………………………………………………………………………….. 184
8.3.1 Implementation as a precaution? …………………………………………………. 184
8.3.2 Unilateral or regional implementation? ……………………………………….. 185
8.3.3 Self-reliance? …………………………………………………………………………… 186
8.3.4 Innovativeness …………………………………………………………………………. 186
8.3.5 Short-term versus long-term options ……………………………………………… 187
8.3.6 Overview of the policy choices ……………………………………………………. 187
8.4 Implementation issues …………………………………………………………………. 189
8.5 Conclusions ………………………………………………………………………………… 192
8.6 Recommendations for European markets …………………………………………. 193
9 Coordination of generation investment with the network ………………………. 195
9.1 Introduction ………………………………………………………………………………… 195
9.2 Analytic framework ……………………………………………………………………. 198
9.3 Policy goals ………………………………………………………………………………….. 200
9.4 The relations between electricity networks and generators …………………….. 201
9.4.1 Introduction …………………………………………………………………………….. 201
9.4.2 Load flow …………………………………………………………………………………. 201
9.4.3 Voltage control ………………………………………………………………………….. 203
9.4.4 System development ……………………………………………………………… 203
9.4.5 Facilitating competition …………………………………………………………… 203
9.4.6 Overview ……………………………………………………………………………….. 204
9.5 Actor perspectives ……………………………………………………………………… 205
9.5.1 The perspective of generating companies ………………………………………. 205
9.5.2 The network managers’ point of view …………………………………………… 205
9.5.3 The interest of consumers ………………………………………………………. 207
9.6 Five market design dilemmas ………………………………………………………… 207
9.6.1 Load flow …………………………………………………………………………………. 208
9.6.2 Voltage control …………………………………………………………………………. 209
9.6.3 Locational incentives to generators ………………………………………………. 210
9.6.4 Network development …………………………………………………………….. 212
9.6.5 Facilitating competition …………………………………………………………… 213
9.6.6 Overview ……………………………………………………………………………….. 215
9.6.7 Consequences of insufficient coordination ……………………………………… 215
9.7 Policy options ………………………………………………………………………………… 219
9.7.1 Objectives ……………………………………………………………………………….. 219
9.7.2 Instruments …………………………………………………………………………….. 219
9.7.3 The limits of incentive regulation ……………………………………………………. 223
9.7.4 Conclusion ……………………………………………………………………………….. 224
9.8 Paradigm shift ……………………………………………………………………………….. 225
9.9 Conclusions ………………………………………………………………………………… 226
9.10 Recommendations ……………………………………………………………………… 229
9.10.1 Policy recommendations ………………………………………………………. 229
9.10.2 Research recommendations ……………………………………………………….. 229
10 Congestion management ………………………………………………………….. 231
10.1 Introduction ………………………………………………………………………………… 231
10.2 Analytic framework …………………………………………………………………… 232
10.2.1 Assumptions ………………………………………………………………………….. 233
10.2.2 Model ……………………………………………………………………………………… 233
10.2.3 Reference Cases …………………………………………………………………… 235
10.2.4 Reference Case 1: No Interconnector …………………………………………… 235
10.2.5 Reference Case 2: Full interconnection capacity ……………………………. 236
10.2.6 Reference Case 3: Optimal allocation of scarce capacity ………………… 238
10.3 The congestion management methods …………………………………………….. 240
10.3.1 Explicit auctioning ………………………………………………………………….. 240
10.3.2 Implicit auctioning …………………………………………………………………… 243
10.3.3 Market splitting ………………………………………………………………………… 245
10.3.4 Redispatching ………………………………………………………………………….. 247
10.4 Impact of the assumptions …………………………………………………. 251
10.5 Congestion in a network ………………………………………………………………. 252
10.6 Comparison of the congestion management methods …………………………. 255
10.6.1 Welfare effects ………………………………………………………………………… 255
10.6.2 Economic efficiency ……………………………………………………………… 256
10.6.3 Long-term signals ……………………………………………………………………. 257
10.7 Conclusions ………………………………………………………………………………… 259
10.8 Recommendations ………………………………………………………………………. 260
10.8.1 Policy recommendations ………………………………………………………. 260
10.8.2 Research recommendations ……………………………………………………….. 260
11 Synthesis and reflection …………………………………………………………….. 261
11.1 Introduction ………………………………………………………………………………… 261
11.2 Common physical features ……………………………………………………… 261
11.2.1 Network externalities ……………………………………………………………… 261
11.2.2 Differences in time constants ……………………………………………………….. 262
11.3 Common policy issues ……………………………………………………………….. 265
11.4 Reflection upon the method and assumptions ………………………………….. 267
11.4.1 Method ………………………………………………………………………………….. 267
11.4.2 Impact of the assumptions ……………………………………………………….. 269
11.5 The limits of competition …………………………………………………………….. 272
11.6 Implications for other sectors ……………………………………………………….. 275
12 Conclusions ………………………………………………………………………………… 277
12.1 Generation adequacy …………………………………………………………………… 277
12.2 Coordination ………………………………………………………………………………. 280
12.3 General conclusions ………………………………………………………………….. 281
12.4 Further research …………………………………………………………………………… 282
References ……………………………………………………………………………………. 285
Appendix: A dynamic model of several capacity mechanisms ……………. 301
A.1 Introduction ……………………………………………………………………………….. 301
A.2 Assumptions ………………………………………………………………………………. 302
A.3 Model structure ………………………………………………………………………….. 306
A.3.1 Electricity price calculation …………………………………………………….. 306
A.3.2 Investment in energy-only and operating reserves markets …………… 309
A.3.3 Investment in a system with capacity requirements ……………………….. 313
A.3.4 Presentation of model output …………………………………………………….. 314
A.4 Model results ……………………………………………………………………………… 315
A.4.1 Base case ……………………………………………………………………………….. 315
A.4.2 Sensitivity analysis of the base case parameter settings ………………….. 317
A.4.3 Capacity payments ……………………………………………………………….. 323
A.4.4 Operating reserves pricing ……………………………………………………….. 323
A.4.5 Capacity requirements ……………………………………………………….. 330
A.4.6 Demand shock ……………………………………………………………………. 333
A.5 Conclusions ………………………………………………………………………………. 337
A.6 Research recommendations ……………………………………………………….. 338
Summary ……………………………………………………………………………………….. 341
Samenvatting ………………………………………………………………………………… 347
Curriculum Vitae ……………………………………………………………………………. 353
NGINFRA PHD THESIS SERIES ON INFRASTRUCTURES ………………………… 105
Abstract
Two aspects of investment in generation capacity in liberalized electricity markets are investigated: the question of whether investment will be sufficient to meet society’s goals for the reliability of electricity supply (generation adequacy) and the question of how to coordinate investment in electricity generation capacity in a competitive market while bound by the physical requirements and limitations of the electricity networks. The study focuses on the situation in European electricity markets. A number of factors discourage generating companies from investing in a level of generation capacity that is optimal for society as a whole. Due to the limited possibilities for the storage of electricity and the low price-elasticity of demand, electricity prices are highly volatile. This, in addition to the lack of historical trend data (due to the short history of liberalized electricity markets), insufficient transparency and high capital costs, causes investment risk to be high. Investment risk is increased by several sources of regulatory uncertainty. Given these circumstances, it is rational for investors to be cautious. A number of policy options for improving investment incentives and for stabilizing the volume of generation capacity, called capacity mechanisms, are described and analyzed. A policy framework is introduced for evaluating them and deciding on the best policy options for different circumstances. With respect to the issue of coordinating investment in electricity generation capacity with the networks, the consequences of the choice for fixed transmission tariffs in most European countries were investigated. While fixed transmission tariffs are intended to make the market simple and transparent, paradoxically they create the need for several additional measures to compensate for their external effects. Among these, the implementation of a congestion management method ranks among the most necessary measures. The options for congestion management, given the choice for fixed transmission tariffs, are analyzed and compared.
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