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Since @chrisnelder has just posted a 90 minute advertisement for my research program, the least I can do is follow through on his request for an "English translation" of my most recent paper (posted here: papers.ssrn.com/sol3/papers.cf…).
As a preface, a spoiler: as long as we have competitive markets, we will have LMP. The L is dictated by the network physics; the M is required if we want competition. I share Pete's intuition that we will continue to want competitive markets going forward.
What sets the marginal price, however, could be much different. Likely candidates are the opportunity cost of storage/demand resources and the marginal value of ancillary services products (which, as discussed, are likely to evolve).
Turning to the paper: what it tries to do is reconcile the concerns that Chris proposes could warrant a "cage match" between Pete and @EricGimon regarding the role of capacity markets.
If I can paraphrase, Pete's concern is that energy-only markets are too risky (i.e., LMPs are too volatile) to support adequate investment, while one of Eric's concerns is that any stifling of volatility inherently undervalues flexibility.
The paper tries to formalize Pete's concern: if adequate risk trading isn't available, the cost of capital will increase and investors will under-build capacity. In the traditional framework, this can't happen because the models assume complete markets for risk trading.
If risk trading is limited in any way, under our model we get worse results out of the markets. In the real world, a common refrain from the generation side (especially nuclear & renewables) is that they would prefer to have an easier time finding long-term contracts.
An important empirical piece missing from this paper is: why might these long-term contracts be unavailable/hard to find? If it's that nobody has the appetite for that risk, maybe it's an appropriate outcome. If there are structural things preventing it, it warrants intervention.
Taking it a step further: introducing a capacity market has the financial impact of one form of risk trading, namely, an option. The demand side pays a fixed price for the "contract," and in exchange the price never goes above some price cap (e.g. $1-2,000/MWh).
We find ourselves in a situation where one form of risk trading is mandated, but other forms of risk trading have limited availability. But, it turns out that options are a very good hedge for technologies with low capital costs and high marginal costs.
With this "asymmetric" availability in trades, it is much easier to de-risk investment in capacity with low capital / high marginal costs. This results in a lower cost of capital, and more of that technology is built.
Earlier in the episode, Pete expresses concern about the large number of resources in New England under long-term contracts. The paper argues that this is exactly the response we want! Resources need risk trading mechanisms suited to their risk profiles.
But, the key is that these contracts must ultimately be settled against the LMP. In order to maintain competitive markets, we want generators to have a) the right incentives for short-term operations and b) appropriate signals for future investment.
In closing, thanks to Chris and Pete for a great episode. In case anyone who made it this far in my thread doesn't already subscribe, get on it: xenetwork.org/become-a-membe…
