Why It is Needed and How Can It be Designed? Conference on Incentives to Build New Generation on Competitive Electricity Markets, Stoccolma 18-19 Giugno 2007 Alberto Gelmini*, Michele Benini*, Massimo Gallanti** *CESI RICERCA The problem of “resource adequacy”, i.e. the structural capability of the system to meet the electric energy demand respecting pre-defined security and quality levels, has become a critical issue in most liberalized electricity markets. Different regulatory mechanisms have been applied worldwide to ensure resource adequacy, ranging from fixed payments administratively defined, such as in Spain, to specific uplifts to power pool prices, proportional to the loss of load probability and to the value of lost load, such as in the old England & Wales electricity market, to the “capacity obligation” markets of the PJM, New York and New England electricity markets, where load serving entities are obliged to buy from producers an amount of generation capacity sufficient to meet their peak load plus a pre-defined reserve margin. Moreover, taking advantage of such experiences, new approaches have been proposed, such as the one based on “call options”, originally devised by prof. Pérez-Arriaga and proposed by the Italian Electric Energy and Gas Regulatory Authority for the Italian electricity market. This approach has been assessed and compared with a more conventional one, based on fixed payments administratively defined, using an electricity market simulator able to model the electric system evolution, the investment dynamics and the related electricity prices over a long-term time horizon. To this aim, a market simulator has been developed which features a short-term cycle, where competition on electricity prices and quantities traded is modeled, nested inside a long-term cycle, where competition on investments in new generation capacity is simulated. The presentation will illustrate the results of the simulations for the Italian market, in terms of reserve margin deriving from the application of the assessed capacity payment models, of their costs as well as of their impact on market prices.