Discussion Paper

Is the Benefit of Reserve Requirements in the “Reserve” or the “Requirement”?

Sep 18, 2008 | Timothy J. Brennan

Abstract

Reliability in electricity markets is, in many respects, a public good, in that one supplier’s failure to meet its customers’ demands can cause failure throughout the grid. This creates a blackout externality. One of the remedies for a blackout externality is a reserve requirement, where load-serving entities have capacity on hand to meet demand in the case of unexpected surges in demand or unit failures. Modeling the magnitude of the externality as a positive function of use and negative function of capacity revealsthat a benefit of capacity requirements is that covering their costs imposes a tax on usage. After illustrating this possibility, a model addressing the sector as a whole, where spot markets can resolveindividual but not overall shortfalls, illustrates that capacity requirements should be increased or decreased to exploit this usage tax effect.