Capacity Markets versus Energy Markets

There are two primary types of electricity markets: capacity markets and energy-only markets. Capacity markets are designed to ensure that there is enough generation capacity available to meet demand, while energy-only markets are focused on selling the electricity that is generated.

In a capacity market, generators are paid for their ability to generate electricity plus the electricity that they actually produce. In an energy-only market, generators are paid only for the electricity that they generate. The total revenue per unit energy supplied may be the same, but the capacity market provides part of that revenue through availability (capacity) to deliver.

Benefits and Drawbacks

Energy-only markets offer the advantage of being more economically efficient because customers don’t pay for assets that aren’t used. The price is also related to how much electricity is being used (market demand), making it a favorable option in regard to cost. However, energy-only markets come with some drawbacks.

First, energy-only markets are more susceptible to price spikes. This is because the price of electricity is directly related to the demand for electricity. If there is a lot of demand, the price will go up, and vice versa. For example, if there is a heatwave and the demand for electricity increases, the price of electricity will go up more than in a capacity market in which only a fraction of the cost is related to energy sales.

Second, energy-only markets result in less reliability. This is because generators may not be able to accurately predict the demand or the risk of unused assets is too high. This can lead to supply shortages and forced outages.

Capacity markets are designed to solve some of these problems. First, capacity markets help ensure that there is always enough capacity available to meet demand. Capacity markets are also less volatile since they are less dependent on real-time demand. Finally, capacity markets are more reliable since they compensate investors for making capacity available.

On the flip side, capacity markets have some drawbacks as well. The first is that capacity markets can be more expensive. This is because capacity payments are usually made on a monthly or annual basis, while electricity is sold at a per-kWh rate. Second, capacity markets can be less flexible. Because of the way payments are made, generators may not be able to adjust their capacity quickly in response to changes in demand.

Overall, capacity markets offer a number of advantages over energy-only markets. Capacity markets are less susceptible to price spikes, more efficient, and more reliable, leading to a more stable and reliable electricity market.

Which Corner Are You In?

There is a debate among policymakers about the best way to ensure that there is enough capacity available to meet demand. Some believe that capacity markets are the best way to do this, while others believe that energy-only markets are a better option.

Where do you stand in the debate? Share your thoughts below.