by Jacob Mays, Michael T. Craig, Lynne Kiesling, Joshua C. Macey, Blake Shaffer, and Han Shu

Energy-only electricity markets, such as the Electric Reliability Council of Texas (ERCOT), rely on the decentralized investment decisions of market participants to lead to a resource mix providing an efficient level of reliability. During an exceptionally cold winter storm in February 2021, ERCOT experienced shortfalls on an unprecedented scale, with nearly half of the generation fleet experiencing outages at the peak. The depth of the resulting blackouts invites questions regarding the ability of systems relying on decentralized planning to appropriately prepare for and withstand rare events. Based on two mild assumptions, risk aversion among investors and incomplete risk trading, this paper offers an explanation for why decentralized markets are prone to underinvestment in resilience. We describe the nature of the incomplete risk trading that arises in the context of electricity markets and discuss potential remedies, including mandatory contracting obligations for retailers and compensation to end users for unserved energy.

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Areas of Focus: Energy Markets
Energy Markets
Well-functioning markets are essential for providing access to reliable, affordable energy. EPIC research is uncovering the policies, prices and information needed to help energy markets work efficiently.