Changing the resource adequacy paradigm from cost recovery to investment incentives

Summary form only given. Traditional capacity payment mechanisms aimed at incentivizing generation investments are backward looking in nature focusing on ensuring cost recovery to incumbent generators rather than on incentivizing efficient capacity expansion. Such mechanisms tend to encourage overinvestment and suppress scarcity signals that would have otherwise promoted demand response. A more market friendly approach that will guide markets toward prudent risk management practices is to impose hedging requirements on load serving entities (LSEs). Such obligations can be met by long-term contracts or mandated forward-looking call options of sufficient duration so as to stimulate new construction when the option premium is high enough.