Moral Hazard in the Electricity Capacity Markets

Abstract

This paper investigates the ways in which an electricity capacity market design may encourage generators to exaggerate their available capacity. For concrete analysis, a simple two-player game model is introduced, focusing on two pure strategy Nash equilibria: an equilibrium at which generators offer their true capacities, and an equilibrium at which generators offer exaggerated capacities. The latter case is caused by asymmetries of information between players and called 'moral hazard' in the economics literature. Our consideration of the practical electricity markets reveals that the moral hazard case is highly probable. Moreover, consideration of the current capacity market design in the real world led us to conclude that the better the electricity energy market performs, the higher the risk of moral hazard becomes. For illustration, a numerical example is presented.