Capacity Payments and the Pricing of Reliability in Competitive Generation Markets

In restructured electric power industries around the world, power pool designers have enabled generators to earn revenues consisting of energy and capacity payments. This paper discusses uses and abuses of capacity payments, and links provision of these payments to the issue of pricing reliability. A general formula for determining the ideal capacity price in a generation supply system is presented and the theoretical basis discussed. Methods of achieving an ideal level of system reliability through price-setting of capacity payments (in more regulated markets) and through price discovery (in more competitive markets) are contrasted. The paper concludes with market design recommendations that could better realize customer preference for reliability at prices customers are willing to pay.