Capacity markets: review and a dynamic assessment of demand-curve approaches

In the absence of significant consumer response to real-time electricity prices, the market does not reveal the value of generation adequacy. As a result, energy markets alone are unlikely to provide the right amount of generation capacity, particularly if they are subject to stringent price caps. The installed capacity (ICAP) markets in the northeastern US markets are a response to this need for additional incentives to construct generation. In the Pennsylvania-Jersey-Maryland (PJM) and New England markets, proposals are being considered to replace the present fixed ICAP requirement that is placed upon load serving entities (LSEs) with a demand-curve based system in which the independent system operator (ISO) would be responsible for acquiring capacity on behalf of LSEs. The demand curve approach pays more when reserve margins are smaller, and reduces disincentives for investment when reserves are above target levels. Other goals of such a system are to make revenues more predictable for generators, making investment less costly, ultimately, lowering prices for consumers. A dynamic model is presented for projecting the effects upon reserve margins, LOLP, generator profitability, and consumer costs, and its application is illustrated with hypothetical demand curves. The method is presently being used to evaluate demand curves for PJM, and the authors intend to present dynamic analyses of the final proposal and its alternatives at the 2005 IEEE Power Engineering General Meeting.