1 Long term system adequacy in the energy system: Capacity obligations VS Reliability contracts: the French Electricity Market Khalfallah Mohamed Haikel GATE (Groupe d’Analyse et de Théorie Economique) University of Lyon2 93, Chemin des mouilles B.P.167 69131 - ECULLY cedex (France) Phone +33(0) 472 86 60 74 Fax +33(0) 472 86 60 90 Khalfallah@gate.cnrs.fr Keywords: Electricity markets, generation capacity adequacy, real options,, dynamic programming. JEL Classifications: C61, L51, O14, O21 Abstract There is no consensus on which energy market design provides the least distorting long-term investment incentives. Theoretical rationale suggests that “energy-only markets” with spot prices that are allowed to reflect scarcity rents should provide an optimal level of investment in generating capacity. However, different market designs with separate payments for capacity or reserve obligations have the advantage of not relying on infrequent price spikes to remunerate reserve capacity. In this paper we analyse potential regulatory mechanisms to ensure sufficient supply of electricity. We describe a dynamic model for long-term investment planning in restructured power systems. First, we study the effect of “Capacity Obligations” and “Reliability Contracts” schemes on the long term capacity adequacy in the system and we analyse how the pricing of CO2 and difference in construction delays for the new power plants would affect investment strategies and the effectiveness of the incentive mechanism. Second, we take into account the uncertainties in future demand and fuel prices and we study the effect of the adoption of the incentive mechanisms on the optimal timing of investments. Resolution of the investment model is based on dynamic programming method and real options theory. We show that reliability contracts mechanism assures the long term system adequacy and encourages earlier investments and appears to be a more cost efficient incentive mechanism than capacity obligations. It is also illustrated that the change in framework conditions and difference between technologies (cost structures and construction delays) would affect investment strategies but without influencing the effectiveness of reliability contracts scheme. Also the dynamic valuation of the investment problem would contribute to further postpone the investment decisions compared to the static assessment.