|Q: Why are you positive that Australia has not solved the adequacy problem with an energy-only market?
Preamble: Two problems are often confused: (1) the adequate-capcity problem, and (2) the optimal-capacity problem. These problems are completely different.
The Adequate-Capacity Problem: How can a market build enough capacity to have an optimal number of blackouts (involuntary load shedding events)?
The Optimal-Capacity Problem: If there is sufficient elasticity (1) to prevent blackouts and (2) to prevent the clearing price from exceeding VOLL, How can the market build the efficient level of capacity for production and consumption?
A: If Australia has an adequacy problem then it is theoretically impossible for an energy-only market to solve it. Such a market has no information about the consumer value of reliability and cannot provide even an approximate solution on its own. It can come close if guided by an administrator/regulator.
The only reason people believe that an energy-only market might solve, or come close to solving. the adequate-capacity problem on its own, is because they have misunderstood standard economics. All econ texts that discuss the investment equilibrium assume that there is so much elasticity that there is no adequacy problem (not even a hint of one). Econ texts, then explain why an energy-only market will solve the optimal-capacity problem.
Can you convince your system engineers that there is no adequacy problem because their is so much elasticity that price will never exceed $2000, and that these prices will always prevent (through elasticity) a blackout from lack of adequacy, and that even though prices remain below $2000 there will be profits enough to induce the level of investment needed to assure the permanent perpetuation of this happy state? If so, then you really don’t have an adequacy problem, and an energy-only market will build the efficient level of capacity as promised by economics–or at least come reasonably close to it.
(If you can prove VOLL is definitely higher than $10,000, then you can substitute $10,000 in the above test.)
|Q: Why does it seem like some energy-only markets are nearly working if the market “doesn’t have clue” and can’t get investment even approximately right?
A: Because every market contains a lot of pricing parameters that are set by administrators and regulators. They know how much capacity is needed and try to set reasonable parameters. When they get them quite wrong on the low side, the generators yell at them. This is because the engineers and regulators keep the system nearly reliable, and with pricing parameters that are too low for an administratively maintained capacity target, investors suffer. (The target is maintained through out-of-market capacity purchases when the parameters are wrong.)
Energy-only markets do work when administrators set their parameters correctly (though they produce too much risk and market power). So, when such a market comes close, it is because the administrators set the parameters about right, not because the market solved the on its own.
|Q: But if an energy-only market can solve the optimal-capacity problem, why not the adequate capacity problem?
A: The optimal-capacity problem is this: would another plant be able to make a profit given the current energy prices. If so, then it should be built because its output is worth more than, or as much as, consumers are willing to pay for power–as demonstrated by the current prices. These prices reflect the willingness to pay of all consumers who would buy more if there were another plant, so this comparison is correct even though some consumers are inelastic (they do not see or pay attention to price). This is standard economics. The market trades off the willingness to pay of price-responsive consumers against the cost of a new plant. This willingness to pay is expressed in the market through the price elasticity of some consumers, and investment costs are seen by investors. The market has the necessary information, and economics proves that a competitive market gets the right answer to this investment problem.
The adequate-capacity problem is completely different and is never discussed in econ texts. It is the problem of how much damage is done to inelastic consumers who are involuntarily blacked out. They would pay some high price to avoid this, but the market never gets even a hint of this price because these consumers pay no attention to price (usually because hourly price has no impact on their bill). This is the reliability problem, and the market has none of the necessary consumer information. Economics makes no claim that markets solve this or any other problem without having the necessary information. It would be a patently absurd claim. This is not a case of “approximately right.” The market cannot tell whether a blacked-out consumer lose $200/MWh or $200,000/MWh or any other amount. Those consumers send no market signal regarding the value they lose when they are blacket out. None.
|Q: Can’t the RA problem be solved with (1) demand response, (2) a demand curve for reserves, and (3) offer caps? The caps would mitigate market power and the demand curve would give efficient scarcity prices.
A: #1 Lack of demand response is a problem with the present world. We agree, fixing that would solve the problem. See the last paragraph on page 23, “One way to solve the reliability problem… Our paper is about what to do in the mean time–we figure that’s only a decade or so.
#2 & #3. We say “the problem is that current market-design parameters, such as offer caps, have been set to control market power, and consequently have been set too low for adequacy.” These parameters include the reserves demand curve. If these parameters are administratively raised to the right level (difficult), that would solve the adequacy problem on average. This solution is not as good as the convergent solution because:
The investment signal is less clear and installed capacity will fluctate more.
The market is much riskier for investors and the premium will be paid by consumers.
With scarcity prices, this high, and no hedge, spot market power will be much worse than under a convergent approach.