The Future of Power Markets in a Low Marginal Cost World

A major contribution from the economics of regulatory practice in electricity markets is the usefulness of marginal cost pricing. In recent years, however, expanded supply of low cost natural gas, increased energy efficiency, growing market penetration of renewable electricity sources, and substantial reserve margins have contributed to low prices reflecting low marginal costs in wholesale energy and capacity markets. These low prices have placed some existing generation assets at financial risk and disrupted the incentive for new investment. While low prices should indicate ample generation capacity, some observers fear they fail to represent the long run scarcity value of electricity and thereby undermine resource adequacy. This paper explores four paradigms for the future of the electricity sector in a low marginal cost world, including traditional cost of service, energy-only power markets, energy plus capacity remuneration mechanisms, and new relationships between providers and consumers on an energy platform. These paradigms are evaluated for their ability to achieve efficient long-run outcomes in the industry and other criteria.