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in my view (continued from p. 100)
of negative prices might become less frequent. In fact, as indicated in the previous section, more flexible demand from
energy storage and power-to-gas facilities will find it particularly convenient
to absorb excess generation when prices
reach very low levels. Thus, flexible demand might prevent prices from falling
into negative territory. The same applies
to electric vehicle charging.
Even without negative prices and
with a less binomial price distribution, it
is likely that the overall level of revenues
accruing to (backup) conventional generation might be insufficient to cover fixed
costs. In the medium term, this could
lead to a reduction in conventional capacity (in the short term, fixed costs are
mostly sunk), negatively affecting system adequacy. The exact policy implications of this possible trend have been the
source of much debate over the years.
One viewpoint in this debate is that
energy-only markets will continue to
provide sufficient price signals and revenues to promote investments in generation capacity. There is a lot of merit in
this position, and, in fact, this is the setup in most other markets (for commodities and services), even though the specificities of electricity system operation,
with its need for instantaneous balance
and its still-limited storage possibilities,
might exacerbate its implications in the
electricity sector. Capacity shortages
will be signaled by frequent electricity
price spikes, possibly to the VOLL. This
will, in the short run, promote demand
response and other forms of demand
flexibility; at prices equal to the VOLL,
consumers should be, by definition, indifferent toward consuming or not consuming. In the longer run, more frequent
high prices would attract needed additional capacity in the market. The European Commission has leaned toward
this view of the electricity market. However, as just indicated, this view implies
that prices occasionally, and possibly
more often than that, reach the VOLL
(in the order of several thousands of euros per megawatt hour, or several euros
per kilowatt hour). In principle, there is
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nothing wrong with this, except that this
sort of price dynamic might be socially
and politically unacceptable.

Capacity Remuneration
Mechanisms
As a result, even the European Commission recognizes the need, in some specific
circumstances and mostly as a transitory
measure, for the deployment of capacity
remuneration mechanisms (CRMs). The
recast of the Electricity Regulation [Regulation (EU) 2019/943], as part of the
Clean Energy for All Europeans package,
has set strict rules in this regard. In particular, CRMs can be introduced only to
address residual adequacy concerns that
cannot be dealt with by measures that
member states have to introduce to eliminate any regulatory distortions. Among
the different CRMs available, legislation
favors the use of strategic reserve.
There is an expectation that residual
adequacy concerns will be temporary.
Therefore, a good feature of CRMs is
that of self-regulation, in the sense of
being able to provide the necessary additional stimulus when adequacy concerns emerge but automatically " retreat "
when these concerns recede. Among the
CRMs proposed or being implemented,
the one based on reliability options,
among others, appears to have such
characteristics. Reliability options, used
as a way of addressing long-term resource adequacy, were first proposed by
Pérez-Arriaga in 1999. As the name reliability options suggests, they are option
contracts that require generators and
other adequacy providers, in exchange
for a fixed fee, to pay the holder of the
contract, in any market time unit, any
positive difference between the equilibrium market price (p) and a predefined
strike price (s). In so doing, these contracts aim to incentivize generators and
other adequacy providers to be available
when the market price is high (above
the strike price), signaling the tightening of the demand-supply relationship,
because in this way, they will be able to
honor payment under the contract with
the higher revenues from the market.

The main advantage of the reliability
option mechanism vis-à-vis other possible CRMs is twofold. On the one hand,
it does not require the predefinition of
scarcity periods (when the contracted
resources are expected to be available),
as it uses the occurrence of high market prices-above the strike price-for
this purpose. On the other hand, the
reliability option mechanism is, admittedly, more market oriented because if
the strike price is set at an appropriately
high level (as discussed later in this article), it activates only when the system is
close to rationing and does not affect the
spot market under normal or even tight
conditions. In this sense, reliability options can coexist well with commercial
long-term financial contracts (e.g., futures or contracts for difference), which
provide hedges against price volatility
for both consumers and generators.
Among EU member states, Ireland
and Italy have decided to implement reliability option-based schemes. Outside
the EU, reliability options have been implemented in Colombia and by ISO New
England, a regional system operator in
the United States. However, in the Irish
and Italian implementations, the distinction between reliability options and
price risk-hedging instruments has been
somewhat lost due to the fact that the
strike price is closely linked to the costs
or the expected offer levels of a peaking
generating unit (capped at €500/MWh
in the Irish implementation).
Setting the strike price in this way
might risk replacing market dynamics with
an administratively set, two-part wholesale
price, which was typical of the regulated
generation sector of the 1990s. The reason
usually provided for this approach is to
control the potential abuse of market power, which, in a competitive market, is better controlled through competition policy
rather than ex-ante regulation.
Over time, other resources, such as
demand response and storage, have entered and will continue to enter the market, which might be promoted by prices
higher than the costs of peaking units. The
relatively low strike prices of reliability
january/february 2021

IEEE Power & Energy Magazine - January/February 2021

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