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Cross-border Effects of Capacity Remuneration Schemes in Interconnected Markets: Who is Free-riding?

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  • Xavier Lambin and Thomas-Olivier Léautier

Abstract

We study the welfare impacts of domestic support schemes for generation capacity when energy markets are interconnected. We find that if transmission system operators (TSOs) can't reduce export capacity and neighbors stay energy-only, a capacity market is ineffective unless transmission capacity is small. If TSOs can reduce export capacity, the capacity market attracts investments and Security of Supply (SoS) of non-domestic markets shrink. A neighboring energy-only or strategic reserve market will thus be prejudiced in the long-run and may have to implement a capacity market as well in order to meet its SoS standard. Hence, capacity markets may spread in Europe thanks to their negative cross-border effect on investment incentives. This is in sharp contrast with the conventional wisdom, based on short-term arguments, that energy-only markets will free-ride the SoS provided by neighboring capacity markets. Our conclusions urge for the harmonization of capacity remuneration schemes across Europe.

Suggested Citation

  • Xavier Lambin and Thomas-Olivier Léautier, 2019. "Cross-border Effects of Capacity Remuneration Schemes in Interconnected Markets: Who is Free-riding?," The Energy Journal, International Association for Energy Economics, vol. 0(Number 6).
    • Handle: RePEc:aen:journl:ej40-6-lambin
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    Cited by:

    1. Zimmermann, Florian & Keles, Dogan, 2023. "State or market: Investments in new nuclear power plants in France and their domestic and cross-border effects," Energy Policy, Elsevier, vol. 173(C).
    2. Zimmermann, Florian & Keles, Dogan, 2022. "State or market: Investments in new nuclear power plants in France and their domestic and cross-border effects," Working Paper Series in Production and Energy 64, Karlsruhe Institute of Technology (KIT), Institute for Industrial Production (IIP).
    3. Astier, Nicolas & Ovaere, Marten, 2022. "Reliability standards and generation adequacy assessments for interconnected electricity systems," Energy Policy, Elsevier, vol. 168(C).

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    JEL classification:

    • F0 - International Economics - - General

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