An experimental study of investment incentives mechanisms in the electricity industry (Revised April 2009)

Energy-only markets are not producing efficient incentives to invest in new generation capacities. Energy spot market prices are short term signals, characterized by spikes and volatility that rise investments risks. New market designs based on the creation of separated long term capacity markets in addition to energy markets aim at correcting this market failure. In this paper, we investigate the efficiency properties of a ldquoforward capacity marketrdquo (FCM), using the methods of experimental economics. Our contribution is in the modeling and experimentation of such a market design. Our results from laboratory experiments show that capacity markets give better private incentives to invest in new capacities that energy-only markets. The capacity mechanism also contributes to lower energy market prices in peak and extra peak demand periods.