IAAE International Conference Singapore June 18-21, 2017 Equilibrium supply security in a multinational electricity market with renewable production Thomas Tangerås Research Institute of Industrial Economics IAAE International Conference Singapore June 18-21, 2017

Equilibrium supply security IAEE, June 18-21, 2017 Background New capacity in electricity markets primarily from variable and non-dispatachble energy sources such as solar and wind A well-functioning market relies upon the balancing of such intermittent production by consumption or other production A growing concern that large shares of renewable electricity production endangers system reliability Proposed solutions: Capacity reserves and market integration Decisions are taken at the national level, but have consequences abroad in multinational electricity market Paper develops an economic model to analyse key questions related to supply security in a multi-national electricity markets

Equilibrium supply security IAEE, June 18-21, 2017 Background Capacity reserves are not only about physical reliability Many markets have price triggers for the activation of reserves EUR/MWh Bid cap X Scarcity rent Max offer Reserve Demand Supply MWh Supply security = Reliable supply at acceptable spot prices

Equilibrium supply security IAEE, June 18-21, 2017 Key findings An increase in the capacity reserve allows to maintain a given level of reliability while insulating consumers against price spikes distorts consumption decisions and market-based investment The socially optimal capacity reserve trades off those two effects Both effects spill over to neighboring countries under market integration Equilibrium capacity reserves can be upward or downward distorted compared to the social optimum in a mutlinational electricity market Which effect dominates depends on two marginal effects A portfolio effect creates a positive externality causing the marginal benefit of insuring consumers to be smaller under market integration A cost efficiency effect of causes the marginal cost of capacity reserves to be smaller under market integration

Equilibrium supply security IAEE, June 18-21, 2017 Key findings Market integration (network investment) is downward distorted relative to the social optimum, even if investment is centralized The socially optimal level of capacity reserves is smaller when financial markets allow consumers to hedge price risk Energy-only market in the limit when financial markets can perfectly hedge all risk Supply security targets defined and solved at the national level increases the cost of capacity reserves and leads to inefficiently high prices

Equilibrium supply security IAEE, June 18-21, 2017 Conclusions and policy discussion The question of physical reliability is to some extent disconnected from the issue of capacity markets Explicit reliability targets Capacity reserves determine the price effects needed to achieve a certain reliability level No general predictions regarding whether countries should be encouraged to or discouraged from increasing capacity reserves Investments in network reliability are downward distorted Congestion rents give insufficient information about marginal value Consumers should pay in excess of marginal valuations because network investment reduces capacity market distortions

Equilibrium supply security IAEE, June 18-21, 2017 Conclusions and policy discussion Develop liquid and well-functioning financial markets important Capacity reserves can be a prerequisite for establishing liquid markets Defining resource constraints and reliability standards and allowing cross-border use of reserves improves resource efficiency and increases the social value of such reserves

Equilibrium supply security IAEE, June 18-21, 2017 QUESTIONS?