Analysis of Generation Investment Under Different Market Designs

In this paper a stochastic dynamic optimization model is used to analyze the effect of different market designs on generation investment and demand. The expansion decisions of profit-maximizing investors are simulated under four different market designs: energy only, capacity payment, capacity obligation, and capacity subscription. The results show that the overall social welfare is reduced compared to a centralized social welfare optimization for the first three policies. In particular, an energy only market with a low price cap leads to insufficient generation investments. Capacity payments and obligations give additional investment incentives and more generating capacity, but also result in a considerable transfer of wealth from consumers to producers due to the capacity payments. In contrast, the capacity subscription policy increases the social welfare, and both producers and consumers benefit. This is possible because capacity subscription explicitly utilizes differences in consumers´ preferences for uninterrupted supply. This advantage must be weighed against the cost of implementation, which is not included in the model.