Michele Benini*, Fabrizio Cremonesi**, Massimo Gallanti*, Alberto Gelmini* Riccardo Martini* Cigre’ 2006- Technical Exbition Exposition Technique Parigi, 28 Agosto, 1 Settembre 2006 *CESI RICERCA **CESI SpA 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. In theory, in a perfectly competitive market, electricity prices should provide sufficient economic signals to market players so that they are incentivized enough both to keep in service power plants that work only during few peak hours (on the basis of the price spikes that would occur in such hours) and to invest in new generation capacity when necessary. In practice, due to several reasons (“political” unsustainability of high prices, investors’ risk aversion, uncertainties for new investments due to possible litigations with local communities, short term demand inelasticity, informative asymmetries, etc.), real markets need specific mechanisms (capacity payments) aimed at explicitly remunerating generation capacity, in order to ensure its adequacy over time and to avoid both high electricity price volatility and so-called “boom and bust” investment cycles, where periods with low reserve margins and high prices alternate to periods with excess of generation capacity and low prices. Different mechanisms have been applied worldwide, ranging from fixed payments administratively defined, such as in Spain, to specific uplifts to the 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 (Pennsylvania, New Jersey and Maryland), 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 load plus a pre-defined reserve margin. As far as the Italian electricity market is concerned, a specific decree (n. 379/03) of the Ministry of Productive Activities established the main criteria for a new capacity payment scheme, i.e.: • be based on competitive, transparent, non-discriminatory and non-distortive mechanisms, aimed at minimizing the economic impact on consumers; • be aimed both at remunerating newly built generating units and to keep in efficient service the existing ones; • be aimed at remunerating also consumers equipped with devices that make them able to provide the reserve service; • be based on capacity targets defined by the Italian Transmission System Operator (GRTN). Within this context, aim of this paper is to report the results of an analysis of different capacity payment schemes proposed for application to the Italian electricity market, in line with the aforementioned criteria. The comparison has been carried out 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, the simulator features a short term cycle, where competition on electricity prices and quantities traded either on the power exchange or bilaterally is modelled, nested inside a long term cycle, where competition on investments in new generation capacity is simulated. The simulator has been specifically tailored in order to model the different capacity payment schemes to be evaluated.