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Why Are We Talking About 

Capacity Markets?

Workshop on Market 

Design and Operation 

With Variable Renewables

Fredericia, Denmark

Michael Milligan, Ph.D.

National Renewable Energy 

Laboratory

Jun 22, 2011

Composite photo created by NREL NREL/PR-5500-52138
National Renewable Energy Laboratory Innovation for Our Energy Future

Outline

• Overview of capacity and why we are 

discussing capacity markets.

• Principles of efficient markets.

• Difficulties with capacity markets.

• The way forward.
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Motivation for Capacity Markets

• Ensure investment/development of sufficient capacity;

• Overcomes some of the difficulties with relying on 

only an energy market;

• Metric is difficult issue – addressed later;

• Does not directly address “operational capacity.”

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High Penetrations of Wind/Solar

• Wind and solar (depending on 

technology) tend to have low 

contribution to planning reserves:

– energy resources supply less 

capacity;

– Partial separation of capacity and 

energy into more specialized 

resources.

• Wind/solar tend to induce lower 

capacity factors from 

conventional units.

• Wind/solar tend to increase the 

need for flexible capacity.
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Market Properties

• What does the 

power system need 

to do?

• What are the 

attributes of a 

system that can 

provide for these 

needs reliably and 

economically?

• How do we design 

market(s) to provide 

for these needs?

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What Does the Market Reward?

• Whatever it is, you will get 

some, even if it is the wrong 

thing.

• Examples of markets-gonebad:

– Executive compensation in the 

early 21 century in the U.S.;

– Market rules/constraints 

imposed in California during the 

power crisis.

• Market rules, metrics, and 

structure can drive behavior.

• So...it is important to know 

what to ask for and how to 

measure it.

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Principles of Competitive Markets

• Efficient: providing what society values 

most highly in cost-effective way;

• Transparent information to all buyers 

and sellers;

• Prices are an efficient signal;

• No externalities, free riders, or public 

goods;

• Sellers have no market power;

• Buyers have no market power;

• One then can prove:

– Long-run equilibrium is stable;

– Long-run equilibrium: P = MC = min(ATC) 

which assures revenue sufficiency and 

social optimum. PIX 17245 
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Long-run Competitive Equilibrium
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Electricity (energy) Markets (most other 

markets too) Are Only Partially Competitive

• Expression of demand is muted by the absence of 

dynamic pricing  price signals are ineffective;

• Elements of supply (transmission, reliability) have 

attributes of public goods and potential free riders;

• Reliability can’t be easily purchased or valued;

• Market power often exists and can be significant;

• Some resources (wind, solar) have near-zero 

marginal cost;

• Implication: MC pricing will not likely allow for 

revenue sufficiency for some generators.
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Implication: Energy Market will not Deliver an 

Economically Efficient Solution

• Point A: excess capacity

• Point B: insufficient capital recovery 

MC

D

MR

P

Q

ATC

A

B
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Capacity Markets

• Purpose: to incent 

investment in new 

generation in the absence 

of transparent signals that 

would result from efficient 

market.

• In principle, this should be 

easy.

• In practice, it is very difficult.

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What Are We Asking the Capacity Market to 

Provide?

• Sufficient capacity to provide for a target 

reliability.

• This would suggest a reliability-based metric to 

measure capacity contribution.
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Effective Load-carrying Capability

Each generator added to the system 

helps increase the load that can be 

supplied at all reliability levels

Gi Gi+1 Gi+2

Added Generators

Combined 

Resources

With 

Wind

Gn-2
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Data and Metric Issues

• Capacity market is essentially a future market.

• What forced outage rate (FOR) to use on 

conventional generation?

• Availability or performance? Trust but verify?

• FOR over non-maintenance hours?

– Can this be gamed?

• How many years of wind/solar data are needed?

• What is reliability worth? 

• Value of lost load (VOLL)?

• How do consumers purchase it and how do you 

measure it?

• How do you eliminate free riders?
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Reliability Can Come from Many Sources

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

1 2 3 4

Wind Only

2004

2005

2006

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

1 2 3 4

Wind with Overlay

2004

2005

2006

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

1 2 3 4

Incremental ELCC from Overlay

2004

2005

2006
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Other Issues

• Interdependency of generators/transmission 

contributions to reliability;

• Monthly capacity market?

• Annual capacity market?
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Inter-annual Variability is Real

0.0

20.0

40.0

60.0

80.0

100.0

120.0

Wind1 Wind2 Wind3 Wind4 Thermal

Percent of rated capacity

Wind Scenario

Avg

Min

Max

MW size also important! Minimum = 0
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Other Potential Metrics

• Planning reserve market.
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PRM is Silent Regarding Reliability
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Simplifications

• Actual capacity factor calculated over high-risk 

periods;

• ISO-NE, NYISO, PJM all do something similar;

• Requires periodic “true-up” with a full reliability 

calculation;

• Advantage: takes individual generator 

performance into account (not by class/size);

• Disadvantage: lack of wind/solar data.

Milligan and Porter, 2008 available at http://www.nrel.gov/docs/fy08osti/43433.pdf.

NERC http://www.nerc.com/docs/pc/ivgtf/IVGTF1-2.pdf.
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Some Potentially Useful Principles

• Horizontal consistency;

• Vertical consistency;

• Ability to account for multiple technologies using 

the same metric;

• “Thought experiments:”

– What does the metric ask for?

– Is that what we want?

– If suppliers provide what the market asks for and 

values, do we achieve the objective?

– Are there any perverse incentives?
Let the 

discussion begin

22

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