1. Comments on “A Capacity Market that Makes Sense” James Bushnell University of California Energy Institute

2. UC Energy Institute2 Reasons Offered Why Capacity Markets Are Needed Factors present in other industries –inelastic demand –lack of storage –capital intensive industry, long-lead times Inefficient rationing of shortages –unwillingness to match demand and supply at retailer level –relatively low price caps (compared to airline bumping)

3. UC Energy Institute3 Arguments for Capacity Markets random rationing creates a “free rider” problem – capacity markets eliminate shirking The costs of getting investment wrong are much greater on the downside than the upside No one likes price volatility, so it is costless to establish standards that reduce volatility To what extent are these self-inflicted problems? –More on this later The distinction between “general” capacity markets and “local” capacity markets

4. UC Energy Institute4 Arguments Against Capacity Markets (those that don’t make sense) Buyers aren’t getting anything for their money –i.e. generators don’t have to do anything Allocation of costs tend to be smoothed amongst many hours Capacity markets in practice distort markets by artificially smoothing price volatility –means more consumption & capacity on peak –means higher average cost Could empower more subtle forms of supplier market power

5. UC Energy Institute5 Designing Capacity Markets Centralization –Capacity “market” vs. Capacity “obligation” –standardized product, organized exchange/auction Timeliness –Planning horizon over which rules are enforced Liability –penalties for not buying, for not building, for forced outages

6. UC Energy Institute6 Liabilities: Generators In “bad” capacity markets, generators are not adequately penalized for non-performance –declare an outage = drive up spot price CS solution – sellers refund all revenues earned from prices above target MC –similar, but not exactly like a low price-cap –makes the demand curve for capacity very important Alternative? – make capacity product a firm energy option –seller bears outage risks, must replace energy –What should be maximum price of option? Lost scarcity rents? Coming from an adminstrative demand curve?

7. UC Energy Institute7 Liabilities: Buyers Time horizons and liabilities –Farther out has bad information and prices volatility is even more reduced –After you fail the check-up then what? pay penalty and be treated like everyone else Why not daily check-ups? –why not hourly? – MSS arrangements

8. UC Energy Institute8 Summary A capacity market that makes more sense than the “bad” capacity markets but A regulation that is always influencing revenues (unlike a high price cap). A form of benchmark regulation based upon the costs of a new CT. –may be necessary for “load pockets” where entry is constrained –why is it necessary for regions with no entry barriers?