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Investment vs. Refurbishment: Examining Capacity Payment Mechanisms Using Stochastic Mixed Complementarity Problems

Capacity remuneration mechanisms exist in many electricity markets. Capacity mechanism designs do not explicitly consider the effects of refurbishment of existing generation units in order to increase their reliability. This paper presents a stochastic mixed complementarity problem to examine the impact of refurbishment on electricity prices and generation investment. Capacity payments are found to increase reliability when refurbishment is not possible, while capacity payments and reliability options yield similar results when refurbishment is possible. Final costs to consumers are similar under the two mechanisms with the exception of the initial case of overcapacity.

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Energy Specializations: Energy Investment and Finance – Corporate Strategy; Energy Investment and Finance – Project Finance; Energy Investment and Finance – Public and Private Risks, Risk Management; Electricity – R&D and Emerging Technologies; Electricity – Markets and Prices ; Energy and the Economy – Other

JEL Codes: L11: Production, Pricing, and Market Structure; Size Distribution of Firms, Q41: Energy: Demand and Supply; Prices, G31: Capital Budgeting; Fixed Investment and Inventory Studies; Capacity, L13: Oligopoly and Other Imperfect Markets, Q40: Energy: General, D43: Market Structure, Pricing, and Design: Oligopoly and Other Forms of Market Imperfection, D21: Firm Behavior: Theory, D22: Firm Behavior: Empirical Analysis

Keywords: Capacity markets, Reliability, Mixed complementarity problem, Stochastic modelling

DOI: 10.5547/01956574.38.2.mlyn

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Published in Volume 38, Number 2 of the bi-monthly journal of the IAEE's Energy Economics Education Foundation.