Strategic behaviour in a capacity market? The new Irish electricity market design

The transition to a low-carbon power system brings the challenges of growing the share of generation from (intermittent) renewables while ensuring security of supply. Policymakers and economists increasingly see a market design based on a capacity mechanism as a way to deal with these challenges. Yet this raises new concerns about the potential exercise of market power by large players via the capacity auction. We present a new modelling approach that captures such strategic behaviour together with an empirical application to the new Irish electricity market design (I-SEM)— in which a single firm controls 44% of generation capacity (excluding wind). The model suggests that costs arising from strategic behaviour in the capacity market are quantitatively significant, even in scenarios with new entry. We also examine how policymakers can measure market power from an ex ante perspective, and how it can be mitigated through auction design.