Optimal reliability and reserve provision in electricity markets with increasing shares of renewable energy sources - analytical insights

We develop a simple analytical model to derive the first-best market equilibrium for electricity spot and reserve markets under stochastic demand and uncertain renewable electricity generation. We then derive the welfare-optimal provision of reserves. At first-best, cost of reserve capacity is balanced against expected cost of outages. We illustrate the analytical results by calibrating the model to the German electricity market. The first-best market equilibrium of the model implies an increase of reserve provision with a growing share of renewable generation. Furthermore, a growing share of renewable generation decreases the level of reliability as measured in energy not served (ENS). Additionally, required reserves to balance higher expected deviations will be more expensive, resulting in a trade-off between higher reserve costs and costs of ENS.