On the viability of energy-capacity markets under decreasing marginal costs

Abstract

This study analyses markets for wholesale electricity that implement uniform-price auctions. We study a model with marginal cost-based regulatory pricing framework where the marginal cost of electricity generation is decreasing. The energy-capacity wholesale electricity market of Western Australia (WEM) is analysed for this purpose. Wholesale markets globally like the WEM need to remunerate electricity generators for the recovery of missing money in electricity generation to ensure resource adequacy as wholesale electricity prices further continue to decline. We show that marginal cost-based price regulation under decreasing marginal cost forces electricity generators to shut down as power producers cannot make a positive profit. The switch to average variable cost-based regulation also induces negative profit for electricity generators in some cases. We recommend that a market regulation under a uniform-price auction arrangement should include price caps to mitigate the high prices and volatility. In the long-term, the return to an energy-only market is a viable possibility.