The Dynamic Efficiency Gains from Introducing Capacity Payments in the National Electricity Market

Australia’s National Electricity Market (NEM) has been a beacon for governments around the world considering power industry reform. However, while the energy-only NEM has served Australia well since 1998, deep structural supply-side faults exist. Competitive energy-only markets do not have a stable equilibrium solution unless reliability constraints are violated, market power is exercised, or scarcity pricing operates unabated. But the political economy of electricity means none of this is likely. This research finds that by reducing the NEM price cap and introducing a ‘capacity payments pool’, a tractable and politically acceptable equilibrium can be established to facilitate timely plant entry.