EBF 483
Introduction to Electricity Markets

9.2 Capacity Markets

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Most restructured electricity markets run by Regional Transmission Organizations feature payments for capacity in addition to day-ahead/real-time energy and ancillary services. These payments typically take the form of forward contracts that last between one and three years, and are determined through an auction mechanism that we'll discuss in detail later in this lesson. Payments take units of $ per MW of capacity per time period (often $ per MW per day or per month). Let's suppose that a 100 MW generator in PJM receives a capacity payment of $100 per MW per day and generates 1,200 MWh per day at a price of $40 per MWh. The generator's daily revenues would be:

  • Energy payment: 1,200 MWh × $40/MWh = $48,000 per day
  • Capacity payment: 100 MW × $100/MW = $10,000 per day
  • Total revenue: $58,000 per day

Capacity payments can be substantial revenue sources for generators and are paid regardless of whether the power plant actually produces any electricity. The same 100 MW generator would get paid $10,000 per day even if it produced no actual electricity.

Markets for electric generation capacity are somewhat odd. They appear to be fairly unique in the energy world. Oil wells live and die on the market price of oil. Pipelines will not be built unless someone is willing to buy the transportation rights. Moreover, they are very controversial. (Everyone in the electricity industry has an opinion about capacity payments but no one ever discusses them in polite company.) The purpose of this portion of the lesson is not to convince you that they are good or bad, but to describe why they exist and how they are determined.