Energy Capacity Markets

The EU Commission and the Agency for the Cooperation of Energy Regulators are looking at options on how best to reward generation adequacy and flexibility in the power markets given the challenges brought by the European policy of moving towards a low carbon society.

Background

Sev­er­al fac­tors have prompt­ed pol­i­cy­mak­ers to open the con­ver­sa­tion on gen­er­a­tion ade­qua­cy and the need to intro­duce capac­i­ty mar­kets in Europe: (i) the increased share of inter­mit­tent renew­able ener­gy in the ener­gy mix of most mem­ber states, (ii) the effects of grad­u­al­ly phas­ing out con­ven­tion­al pow­er plants fol­low­ing the imple­men­ta­tion of the Large Com­bus­tion Plant Direc­tive and the Indus­tri­al Emis­sions Direc­tive, (iii) the nuclear phase-outs or restric­tions to build new nuclear, and (iv) stricter stan­dards for build­ing new pow­er. All these fac­tors have caused con­ven­tion­al pow­er plants dif­fi­cul­ties in secur­ing rea­son­able prof­itabil­i­ty, which in the longer term can seri­ous­ly harm future invest­ments need­ed to main­tain a sat­is­fac­to­ry lev­el of secu­ri­ty of sup­ply. The increased capac­i­ties of inter­mit­tent renew­able sources of ener­gy have sub­se­quent­ly ampli­fied the need for more back up reserves and flex­i­bil­i­ty avail­able in a sys­tem.

To avoid the worst case sce­nario, where all these fac­tors can poten­tial­ly cause black­outs across Europe, it is imper­a­tive to address the issue of secu­ri­ty of sup­ply by incen­tivis­ing the mar­ket par­tic­i­pants to invest in new gen­er­a­tion capac­i­ties.

The incen­tive takes the form of a mech­a­nism called capac­i­ty remu­ner­a­tion, which aims to pro­vide mar­ket par­tic­i­pants with a stim­u­lus in addi­tion to the pay­ments made avail­able under an “ener­gy-only” mar­ket. The capac­i­ty mar­kets are meant to pro­vide investors with a secure stream of rev­enue in the form of capac­i­ty remu­ner­a­tion that rewards the mar­ket par­tic­i­pant not only for deliv­er­ing ener­gy into the sys­tem but also for being avail­able to deliv­er when request­ed by the mar­ket oper­a­tor.

In a per­fect ener­gy-only mar­ket with­out any mar­ket fail­ures, the oper­at­ing and cap­i­tal costs of a pow­er plant could be recov­ered exclu­sive­ly through the mar­ket price, and there are no pay­ments for capac­i­ty.

In Novem­ber 2012 the EU Parliament’s Indus­try, Research and Ener­gy Com­mit­tee request­ed the Agency for the Coop­er­a­tion of the Ener­gy Reg­u­la­tors (ACER) to issue an opin­ion on capac­i­ty mar­kets. ACER has issued both an opin­ion in Feb­ru­ary 2013 and a report in July 2013. The Com­mis­sion is expect­ed to also issue a com­mu­ni­ca­tion on pub­lic inter­ven­tion in the elec­tric­i­ty sec­tor, includ­ing on capac­i­ty mar­kets.

Capacity remuneration mechanism

ACER under­lines the fact that in an inte­grat­ed Euro­pean ener­gy mar­ket secu­ri­ty of sup­ply can­not be just a nation­al con­cern and should be addressed at the Euro­pean, or at least region­al, lev­el. Cur­rent­ly there is no uni­form approach of capac­i­ty remu­ner­a­tion across Europe, as the mem­ber states are pur­su­ing a nation­al gen­er­a­tion ade­qua­cy pol­i­cy. Fin­land, Greece, Ire­land and North­ern Ire­land, Italy, Por­tu­gal, Spain, and Swe­den have imple­ment­ed capac­i­ty remu­ner­a­tions. Bel­gium, Den­mark, France, Ger­many and Great Britain are con­sid­er­ing intro­duc­ing a capac­i­ty mar­ket. The rest of the mem­ber states have no capac­i­ty remu­ner­a­tion in place, nor are they con­sid­er­ing intro­duc­ing one soon.

Capac­i­ty remu­ner­a­tion can be vol­ume-based or price-based. The vol­ume based remu­ner­a­tion can be tar­get­ed; takes the form of strate­gic reserves or mar­ket-wide; and takes the form of capac­i­ty oblig­a­tion, capac­i­ty auc­tion, or reli­a­bil­i­ty option. The price-based mech­a­nism takes the form of a capac­i­ty pay­ment.

Most of the capac­i­ty remu­ner­a­tions in place in the mem­ber states men­tioned above are there to ensure gen­er­a­tion ade­qua­cy but also to pro­vide more flex­i­bil­i­ty and to reduce price risk and price volatil­i­ty.

Risks associated with capacity markets

Giv­en their pur­pose, capac­i­ty remu­ner­a­tions (besides cre­at­ing an incen­tive for the mar­ket par­tic­i­pants to invest in new gen­er­a­tion capac­i­ties) can dis­tort prices and cross-bor­der com­pe­ti­tion, and in the long term can influ­ence invest­ment deci­sions in ener­gy infra­struc­ture (for exam­ple, cre­at­ing less cross-bor­der infra­struc­ture or invest­ing less in stor­age and demand side man­age­ment) since the vol­ume and price risks can be con­trolled via the capac­i­ty remu­ner­a­tion.

In its opin­ion to the par­lia­ment, ACER has under­lined the fact that a capac­i­ty mar­ket should be imple­ment­ed only when and to the extent that ener­gy-only mar­kets can­not pro­vide suf­fi­cient incen­tives on their own for the invest­ments that are need­ed, and they should have as lit­tle influ­ence as pos­si­ble on the ener­gy mar­kets.

ACER has pro­posed that pri­or to design­ing and imple­ment­ing a cer­tain type of capac­i­ty remu­ner­a­tion region­al­ly or across Europe, at least the fol­low­ing mat­ters must be first addressed: a com­mon or region­al approach for assess­ing the secu­ri­ty of sup­ply and gen­er­a­tion ade­qua­cy lev­el, and ensur­ing access to the secu­ri­ty of sup­ply and flex­i­bil­i­ty resources pro­vid­ed by gen­er­a­tors in anoth­er mem­ber state.

Capacity markets should be introduced at least at a regional (if not European) level. They should be compatible with the electricity target model. And their design should prevent distortions to the functioning of the internal energy market and cross border trading. The introduction of national capacity markets should follow only after a sound and detailed impact assessment.