Energy only, capacity market and security of supply. A stochastic equilibrium analysis

Former generation capacity expansion models were formulated as optimization problems. These included a reliability criterion and hence guaranteed security of supply. The situation is different in restructured markets where investments need to be incentivised by the margin resulting from electricity sales after accounting for fuel costs. The situation is further complicated by the payments and charges on the carbon market. We formulate an equilibrium model of the electricity sector with both investments and operations. Electricity prices are set at the fuel cost of the last operating unit when there is no curtailment, and at some regulated price cap when there is curtailment. There is a CO2 market and different policies for allocating allowances. Todays situation is quite risky for investors. Fuel prices are more volatile than ever; the total amount of CO2 allowances and the allocation method will only be known after investments has been decided. The equilibrium model is thus one under uncertainty. Agents can be risk neutral or risk averse. We model risk aversion through a CVaR of the net margin of the industry. The CVaR induces a risk neutral probability according to which investors value their plants. The model is formulated as a complementarity problem (including the CVaR valuation of investment). An illustration is provided on a small problem that captures the essence of today electricity world: a choice restricted to coal and gas, a peaky load curve because of wind penetration, uncertain fuel prices and an evolving carbon market (EU-ETS). We show that we might have problem of security of supply if we do not implement a capacity market.