Abstract

Some regions of the United States have created institutions known as capacity markets in an effort to use competitive market forces to ensure adequate electricity supply at lowest cost. But capacity markets are driven more by political and bureaucratic judgments than by competition. The manner in which the capacity market is designed to determine demand exemplifies this observation. As there is no natural demand for capacity, Regional Transmission organizations (RTOs) administratively create demand in capacity markets. RTOs derive capacity demand from three components: the capacity requirement based on forecasted peak demand plus an additional margin, the net cost of new entry based on the cost of new facilities entering the market, and the shape of the demand curve. The processes that RTOs use to generate each of these components lack theoretical or analytical justification and tend to produce biased results. As a result, electricity customers are paying billions of dollars for excess capacity that is unnecessary to maintain adequate grid reliability. Capacity markets should address these shortcomings so that demand reflects the actual value of capacity.

ISSN

0270-9163

Publisher

Energy Bar Association

Disciplines

Energy and Utilities Law | Law

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