Indivisibilities in investment and the role of a capacity market

Abstract The topic of pricing non-convexities in power markets has been explored vividly in the literature and among practitioners for the past twenty years. The debate has been focused on indivisibilities in short-term auctions, the computational tractability of some pricing proposals, and the economic analysis of their behavior. In this paper, we analyse a source of non-convexities that is not discussed as broadly: the indivisibilities in investment decisions. The absence of equilibrium that we are primarily concerned about is the long-term equilibrium. We derive a capacity expansion model with indivisibilities and we highlight the issues arising from it. We discuss its relevance and address one particular argument for neglecting indivisibilities in investment, namely market size. We investigate to what extent a capacity market that clears discrete offers can mitigate the lumpiness problem. We particularly introduce the novel concept of convex hull pricing for capacity auctions. We illustrate the main findings with a numerical experiment conducted on the capacity expansion model used by ENTSO-E to assess the adequacy of the entire European system.