Many liberalized electricity markets use capacity mechanisms to ensure that sufficient resources will be available in advance of operations. Recent events have called into question the ability of capacity mechanisms to provide sufficient incentives for reliability. A core resource adequacy challenge is that, given the high value of reliable electricity, penalties for non-performance on capacity obligations are lower than what theory would suggest is economically efficient. Weak non-performance penalties give suppliers an incentive to overstate their contributions to reliability. However, stronger penalties will often not be enforceable because suppliers can discharge their obligations through bankruptcy. In principle, system operators can mitigate the effect of weak incentives by conducting accreditation studies that limit the size of the capacity obligation taken on by suppliers. However, political, economic, and technical factors lead to accreditation values that are systematically too high. We discuss the ensuing threats to reliability, the difficulty of implementing "pure market" solutions, the inefficient around-market actions that system operators may take in response, and the potential for the size of the effects to grow with a shift to variable renewable resources.
Working Paper, School of Civil and Environmental Engineering, Cornell University