Market Mechanisms for Low-Carbon Electricity Investments: A Game-Theoretical Analysis

Abstract: Electricity markets are transforming from the dominance of conventional energy resources (CERs), e.g., fossil fuels, to low-carbon energy resources (LERs), e.g., renewables and energy storage. This work examines market mechanisms to incentivize LER investments, while ensuring adequate market revenues for investors, guiding investors' strategic investments towards social optimum, and protecting consumers from scarcity prices. To reduce the impact of excessive scarcity prices, we present a new market mechanism, which consists of a Penalty payment for lost load, a supply Incentive, and an energy price Uplift (PIU). We establish a game-theoretical framework to analyze market equilibrium. We prove that one Nash equilibrium under the penalty payment and supply incentive can reach the social optimum given quadratic supply costs of CERs. Although the price uplift can ensure adequate revenues, the resulting system cost deviates from the social optimum while the gap decreases as more CERs retire. Furthermore, under the traditional marginal-cost pricing (MCP) mechanism, investors may withhold investments to cause scarcity prices, but such behavior is absent under the PIU mechanism. Simulation results show that the PIU mechanism can reduce consumers' costs by over 30% compared with the MCP mechanism by reducing excessive revenues of low-cost CERs from scarcity prices.