IEEE Power & Energy Magazine - January/February 2021 - 99

options can act as de facto price caps that
may discourage the participation of such
new resources. While reliability options
typically operate only in the day-ahead
market (although in Ireland, the market
reference price is a weighted average of
the day-ahead, within-day, and balancing markets prices) and demand response
and storage as well as other decentralized
resources can also operate in the intraday and ancillary services markets, there
does not seem to be any good reason to
effectively exclude such decentralized resources from the day-ahead market.
In my view, the strike price of reliability options, because of their purpose
to ensure adequacy and not to regulate
the wholesale price, should be set at a
level that represents the conceptual discriminant between market functioning,
including under tight conditions, and the
situation in which nothing could prevent
prices to increase up to the VOLL. In
their 2002 seminal work on reliability
options, Vázquez et al. suggested that
the strike price could be considered " as
a frontier between the normal energy
prices (p < s) and the near-rationing or
emergency prices (p > s). " At that time,
a markup of 25% above the variable cost
of the most expensive generator expected to produce was considered sufficient.
Today, with additional resources available to ensure adequacy, such a reference
to generation capacity appears outdated,
but the general consideration of the strike
price as the frontier to near-rationing
levels remains valid. This frontier level
for the strike price is clearly not the cost
of a peaking unit in the market because
some other resources, such as demand
response, storage, and other decentralized resources, would be attracted to the
market only by much higher prices.
Such higher prices have occurred in
the EU electricity market in recent years
without creating any particular disruption. According to the ACER/CEER
2019 Market Monitoring Report, hourly
day-ahead prices higher than three times
the (theoretical) variable cost of a gasfired power plant have occurred close
to 3,500 times from 2015 to 2018, with
nearly 1,500 occurrences in 2016 alone.
In fact, in 2017, when defining the harjanuary/february 2021

monized maximum clearing price for
the day-ahead market coupling, ACER
set an initial value of €3,000/MWh, with
the possibility of an automatic upward
dynamic adjustment if the clearing price
in the market exceeded 60% of the applicable maximum value. ACER's decision shows that even prices in the thousands of euros per megawatt hour, and
not just those in the hundreds of euros,
can be expected and should not be considered as anomalous-to the extent that
they lead to an upward revision of the
maximum clearing price.
Let me conclude with one final observation regarding the design of reliability
option mechanisms, which is often overlooked. Reliability option schemes clearly provide a more stable revenue stream
for contracted reliability resources. However, unless they include a penalty for
nondelivery when the option is called,
they may be seen as not providing additional incentives for adequacy providers
to be available during times of scarcity.
This is clear if we consider, as an
example, the difference in the payouts
(including variable costs, as fixed costs
do not depend on production levels) for
generators between producing and not
producing at times when the market
price exceeds the strike price, both with
and without a reliability option. Without
a reliability option contract, the incentive
for a generator to produce when prices are
high would be the (gross) margin that it
could obtain from selling its electricity in
the market, i.e., the difference between the
price it receives and its variable costs. If
the generator has entered into a reliability
option contract, it would receive the contract fee irrespective of the price level in
the market and whether it produces or not.
Moreover, if prices rise above the strike
price, it would have to make the contract
payment of the difference between the
market price and the strike price, again,
irrespective of whether it produces or
not. Therefore, the incentive to produce
would be the margin that it can obtain
from producing and selling its electricity
in the market, i.e., the difference between
the price it receives from the market and
its variable costs, the same as in the case
without the reliability option contract.

Only when a nondelivery penalty-
imposed on the contracted generator
that fails to produce at high prices-is
included in the reliability option scheme
does the incentive to produce when
prices are higher than the strike price
become greater than without such an option. The Irish implementation does not
envisage nondelivery penalties while
the Italian one has two sets of penalties. Note that the inclusion of a penalty
neither presupposes nor is equivalent to
physical prequalification, as required
by some schemes. The penalty is still a
financial charge, increasing the incentive to produce when the market price is
higher than the strike price, but the writer of the option still needs to secure the
necessary physical generation capacity
during times of high prices.

Concluding Remarks
As more countries are tempted to introduce CRMs to address residual adequacy concerns raised by the greater
penetration of renewable-based generation, prompting them to consider reliability option schemes as the preferred
approach due to their market-oriented
characteristics, these schemes must be
appropriately designed. In particular, the
strike price should not interfere with the
functioning of the energy market under
normal or even tight conditions and penalties should be envisaged that reinforce
incentives for adequacy resources to be
available during times of scarcity.

For Further Reading
I. J. Pérez-Arriaga, " Reliability in the new
market structure (part 1), " IEEE Power
Eng. Rev., vol. 19, no. 12, pp. 4-5, Dec.
1999. doi: 10.1109/MPER.1999.808165.
C. Vázquez, M. Rivier, and I. J.
Pérez-Arriaga, " A market approach to
long-term security of supply, " IEEE
Trans. Power Syst., vol. 17, no. 2, pp.
349-357, May 2002. doi: 10.1109/TPWRS.2002.1007903.
P. C. Bhagwat and L. Meeus, " Reliability options: Can they deliver on their
promises? " Electricity J., vol. 32, no.
10, p. 106,667, 2019. doi: 10.1016/j.
tej.2019.106667.
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