An advanced reliability reserve incentivizes flexibility investments while safeguarding the electricity market.

To ensure security of supply in the power sector, many countries are considering capacity mechanisms. Simultaneously, the expansion of variable renewables increases the need for power sector flexibility, with promising options on the demand side. We analyze how a centralized capacity market and an advanced reliability reserve with a moderately high activation price affect demand-side flexibility investments in a German 2030 case study. Using a capacity expansion model with detailed demand-side flexibility potentials, we show that a centralized capacity market caps wholesale market prices, thereby reducing incentives for flexibility investments. The reliability reserve induces seven times higher flexibility investments in energy-intensive industries and twice as high investments in district heating storage, while achieving security of supply at similar electricity supply costs. The reliability reserve could create a learning environment for flexibility technologies to support the transition to climate neutrality, and policymakers should consider it in forthcoming capacity mechanism decisions.