Is the Benefit of Reserve Requirements in the 'Reserve' or the 'Requirement'?

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 are reserve requirements, where load serving entities have capacity on hand to meet demand in case of unexpected surges in demand or unit failures. We model the magnitude of the externality as a positive function of use and negative function of capacity. Doing so reveals that a benefit of capacity requirements is that covering their costs imposes a tax on usage. After illustrating this possibility, a model looking at the sector as a whole, where spot markets can resolve individual but not overall shortfalls, illustrates that capacity requirements should be increased or decreased to exploit this usage tax effect.