To understand what is driving the decision to implement a capacity mechanism, let’s consider the so-called Energy-Only Market, meaning a market where there is not such capacity scheme.
In this “classical” market, Utilities are rewarded for their generation, meaning the electricity they actually deliver.
If one has a glance to the electricity spot prices, he or she will notice that it has steadily declined over the last years. The day-ahead auction price has settled around 25 €/MWh during most of 2016 in Central West Europe for instance.
These historic low levels can be explained by a systemic oversupply situation, which is exacerbated by the combined effect of growing penetration of renewables -whose capacities have benefitted from guaranteed tariffs and grid priority access (negative spikes)- and energy efficiency measures. As a result, Utilities have reduced investment and mothballed or even decommissioned non-profitable assets, those with the highest marginal cost[iii], fossil fuel plants. As emphatically stated in the EnergyPost, “thermal power plants […] are under existential threat from recent growth in renewable power”[iv].
Fortunately, these stations –those that burn coal, oil, or gas- are major contributors to global warming[v] and one can be positive about such economic retirement. But on the opposite, they can be essential to ensure supply/demand balance when today’s network is facing peak that cannot be covered by the weather-dependent renewables. As long as power storage has not gone down enough the learning curve and demand-response management has not been implemented on a large scale, running fossil fuel plants may be necessary to safeguard against power shortages.
In a context of supposed market failure, some people advocate that incentivizing conventional generation is nothing more than a matter of energy security.
This is a rationale for implementing “a safety net”, for the IEA, “that can complement energy market scarcity rents”[vi] to keep capacity units online or build new one regardless of whether they produce any electron.
Capacity mechanisms are a kind of aid, whose beneficiaries are not only the aforementioned thermal power stations owners but any capacity and even demand side operators. It offers an extended financial visibility to these actors, conducive to investment.
In European Commission’s texts, capacity mechanisms are described as following:
“Typically, capacity mechanisms offer additional rewards to electricity capacity providers, on top of income obtained by selling electricity on the market. This is in return for maintaining existing capacity or investing in new capacity needed to guarantee the security of electricity supplies.”[vii]
There is a great variety of design for such a goal. The same Commission, while conducting a sector inquiry into capacity mechanisms in eleven member states[viii], has found no less than thirty-five capacity mechanisms split into six categories.
On the one hand, there are the targeted mechanisms, which “give support only to the extra capacity required on top of that provided by the market without subsidies”. This is the case of strategic reserve, which is the most common type of capacity mechanism in Europe, as adopted in Germany, Belgium, Poland, and Sweden. Network operators are asked to procure a certain amount of capacities, which are held in reserve outside the market and called upon only in scarcity situation.
On the other hand, some countries, among which France and priorly United Kingdom but also Italy and Ireland, have decided to implement a market-based process. A new market is settled where certificates representing power capacity at a certain date are traded.
Let’s add that some mechanisms, known as interruptibility scheme, target demand response operators.
In part II, we will focus on the French and British schemes in order to detail their characteristics and extract some key learnings.
[i] European Commission. (February 7, 2018). “State aid: Commission approves six electricity capacity mechanisms to ensure security of supply in Belgium, France, Germany, Greece, Italy and Poland.” Press release. http://europa.eu/rapid/press-release_IP-18-682_en.htm
[ii] European Commission. (November 8, 2016). “State aid: Commission approves revised French market-wide capacity mechanism.” Press release. http://europa.eu/rapid/press-release_IP-16-3620_en.htm
European Commission. (July 23, 2014). “State aid: Commission authorises UK Capacity Market electricity generation scheme.” Press release. http://europa.eu/rapid/press-release_IP-14-865_en.htm
[iii] Operating cost for an addition kWh of output.
[iv] Gerard Wynn. (December 16, 2016). “A rush to subsidies as power plants in Europe face existential threat.” EnergyPost.eu. http://energypost.eu/rush-subsidies-power-plants-europe-face-existential-threat/
[v] Due to associated greenhouse gas emissions
[vi] International Energy Agency. (2016). “Re-powering Markets.” OECD/IEA, Paris. https://www.iea.org/publications/freepublications/publication/REPOWERINGMARKETS.pdf
[vii] European Commission. (November 13, 2015). “State aid: Commission opens in-depth investigations into French plans to remunerate electricity capacity.” Press release. http://europa.eu/rapid/press-release_IP-15-6077_en.htm
[viii] European Commission. (November 30, 2016). “Final Report of the Sector Inquiry on Capacity Mechanisms.” Final Report. http://ec.europa.eu/competition/sectors/energy/capacity_mechanisms_final_report_en.pdf
[ix] European Commission. (April 29, 2015). “State Aid: sector inquiry into capacity mechanisms – frequently asked questions.” Fact Sheet. http://europa.eu/rapid/press-release_MEMO-15-4892_en.htm