Capacity markets: A necessary evil in the energy transition?

Steam rises from the brown coal-fired power plant Niederaussem operated by RWE in Bergheim, Germany, 29 October 2017. [EPA-EFE/SASCHA STEINBACH]

This article is part of our special report Capacity markets for electricity.

Detractors of capacity mechanisms argue they are mere state aid for dirty fossil fuels that should be eliminated as soon as possible while supporters claim they provide vital back-up in the transition to renewable electricity. The fact that both are correct is leaving Europe in a quandary.

At first glance, the case for capacity mechanisms appears thin. Those national support schemes were put in place to prop up polluting coal or gas-fired power plants that would otherwise be struggling to make a profit in the face of growing shares of cheap electricity coming from wind and solar.

Moreover, they can distort competition, hampering the European Union’s efforts to build a single energy market allowing for the seamless exchange of electricity across borders.

A revision of electricity market rules, tabled by the European Commission in November 2016, is currently being examined by EU legislators. So cutting the lifeline would appear like the obvious thing to do.

The question is how soon this can be done, and at what cost – both financial and political.

“Security of supply and decarbonisation are key objectives” of the reform, said Florian Ermacora, head of unit for wholesale electricity and gas markets at the European Commission’s energy directorate.

“And all evidence shows it’s the market, not state intervention,” which can achieve those twin objectives at the least cost, he told a EURACTIV event on 4 September. For the Commission, the case for more Europe is clear. “It’s the European market, not national markets” taken in isolation which is best placed to deliver, Ermacora insisted.

The argument sounds compelling. But that hasn’t stopped member states from putting up “capacity mechanisms” in place anyway, claiming they are needed for supply security reasons in the transition to clean energy.

Back-up or abuse?

“You need confidence in fossil fuels capacity in case renewables aren’t available,” says Michael Pollitt, a Professor at Cambridge University who is leading a research project on the EU electricity market design for the Centre on Regulation in Europe (CERRE), a think tank.

Counter-intuitively, he argues capacity schemes are actually necessary to accompany the transition to renewables and may even contribute to achieving the EU’s decarbonisation goals under the Paris Agreement.

“The argument in favour of CO2 reduction is that, by providing support for fossil fuel capacity, capacity markets allow EU countries to go towards higher percentages of renewable energy production. It gives them the confidence of having backup capacity when wind and solar are not available,” Pollitt told EURACTIV in an interview.

Academic: Fossil fuel back-ups ‘may be the price to pay’ for renewables

It’s a contradiction that policymakers are currently struggling to resolve. But fossil fuel back-up plants are probably necessary in the short term in order to give EU countries the confidence to bring in higher shares of renewable electricity, says Michael Pollitt.

Over time, however, he says the utilisation of capacity mechanisms by fossil fuel energy should decline as the share of renewable energy rises. The whole difficulty is to put safeguards in place to make sure there are no abuses.

“If you keep old dirty plants on the system via a national capacity mechanism, and allow them to continue trading – that’s distorting cross-border flows of electricity,” Pollit says, which undermines Europe’s clean energy goals.

“For example, a Polish coal plant receiving capacity payments might still produce electricity at times when the system isn’t stressed and trade it outside of Poland, even though it may not be necessary from a European point of view,” he explains.

“And then you’re detracting from the European energy and climate targets. I think that is the danger – that you keep a lot of unnecessary plants on the system from the perspective of the single market,” Pollitt says.

The contract length offered to bidders in capacity markets are a key potential source of abuse, he states, arguing overly generous contracts of – say – four years can end up looking like a subsidy.

“The value of these longer-run contracts is not clear to me,” Pollitt says. “We need short-term operating reserves in the electricity system – that is true. And some shorter-run contracts would seem to be more suitable to providing that.”

Poland’s ‘last coal power plant’ faces €1.7 billion loss, analysts say

The planned phase-out of state aid to fossil fuel power generation across the European Union could make the Ostrołęka C coal station project unprofitable within years, according to a new report by Carbon Tracker, a think tank.

Security of supply – a national competence

Still, member states can always argue capacity mechanisms are necessary from an energy security perspective – in order to avoid blackouts, or to meet peak demand in winter time.

This is why policing those schemes has felt like herding cats for the European Commission – at the end of the day, capacity mechanisms are about energy security, which is a national responsibility.

“National governments have a responsibility to ensure security of supply,” said Virginie Schwarz, director for Energy in the French ecology ministry. “If there is a blackout, citizens will turn to their government, not to the European Commission,” she told a webinar hosted last week by the Make Power Clean campaign, a business coalition arguing for strict CO2 emission standards in capacity schemes.

Security of supply is indeed a national competence, a point that was stressed again last week by the governments of Poland, France, the UK, Italy, Greece, Hungary and Ireland. “As such it should ultimately be for them [the member states] to determine whether it is necessary to introduce a capacity mechanism within their own market,” the seven countries said in a common position paper.

The European Commission recognises this. But that doesn’t mean member states can “do whatever,” Ermacora said. First, capacity mechanisms must get the approval from the Commission’s department in charge of state aid controls, he reminded, which means observing EU single market rules.

However, Brussels has been forced to adopt a rather lenient approach until now. And EU regulators now want to tighten the screw as part of the proposed electricity market reform.

“I think the Commission has realised that capacity markets are going to happen whether it likes it or not. And it decided it was preferable to get ahead of the issue rather than let capacity markets pop up all over Europe with different designs,” says Michael Pollitt.

Analyst: ‘Member states can strong-arm Brussels on energy policy’

From nuclear plants in the UK and Hungary to coal-fired power stations in Germany, member states always manage to forge ahead with their energy projects, according to Georg Zachmann, who calls on EU leaders to sit down and seriously discuss the Energy Union’s governance.

Looking beyond borders

One key provision in the Commission proposal is to encourage member states to look beyond their borders for available electricity instead of relying on back-up power plants at home. The EU Executive wants to “Europeanise” national capacity mechanisms by creating cross-border bidding zones allowing generators in neighbouring countries to participate.

Breaking down national barriers will decrease the need for capacity across Europe and within countries, the Commission argues. And placing a CO2 emission on power plants allowed to bid in capacity markets will speed-up closure of the most polluting coal plants, it says.

Moreover, “regional operational centres” envisaged under the proposed new market rules should look into all cross-border aspects of electricity trade, including rules for the configuration of bidding zones.

EU pins hopes on ‘regional forums’ to unlock electricity trade

A seamless pan-European energy market is still a long way off, but decisive steps can be taken now with stronger regional cooperation and the introduction of cross-border bidding zones for electricity, policymakers and industry experts argue.

However, EU countries seem reluctant to make such a leap forward. Their natural inclination remains to rely on tried and tested national back-up power plants that can be switched on at will.

Lack of cross-border interconnection is part of the explanation. Without physical power lines, cross-border exchanges simply cannot happen.

European countries have postponed an earlier objective of linking up at least 10% of power grids to 2020, which was originally planned for 2010. And a proposal to link up 15% of Europe’s electricity networks by 2030, envisaged in the current reform, might not survive the negotiations.

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Even when the infrastructure exists, it is not used to its full extent. According to estimates by the Agency for the Coordination of Energy Regulators (ACER), utilisation currently averages 31% of existing interconnector capacity, leading to inefficiencies.

At worse, EU antitrust authorities have suspected transmission system operators (TSOs) of protecting their national market by systematically restricting cross-border electricity flows.

A question of trust – and cost

But achieving a truly integrated European market where EU countries have less capacity than their total demand is “a big ask” for a sector obsessed with the risk of blackouts, Pollitt says.

“Virtually no member state is in a position to do that at the moment,” he argues.

The issue boils down to a lack of trust between EU member states. Fabien Roques, an Associate Professor at Paris Dauphine University and consultant with Compass Lexecon, says the technical aspects of grid interconnection and cross-border exchanges can be solved relatively easily.

“The real issue is the political will to be in solidarity when there is a shortage,” he told EURACTIV in e-mailed comments. Which means adopting operational rules to guide the rationing of power at regional level and to align the TSOs responsibilities accordingly.

“That is not an easy issue to solve as this is not just about national sovereignty: this means in practice accepting that customers on one side may be cut off to guarantee supplies on the other side, with potentially significant economic implications…,” Roques says.

Roques believes regional approaches offer part of the solution to greater European energy market integration and solidarity. But he warns that regional coordinators “should not be seen as a substitute for political and operational agreements between member states and TSOs”.

In France for instance, the national Transmission System Operator, RTE, has signalled it will not engage in cross-border exchanges without first signing a bilateral agreement with the neighbouring TSO.

This is why Roques believes a step-by-step approach should be adopted, “building on the current Regional Service Coordinators to gradually extend their role and responsibilities,” in parallel with a broader alignment of policies.

“The risk is to create a disconnect between the operational responsibilities and the underlying regulatory and policy framework,” Roques warns.

Fabien Roques: EU needs adaptable electricity ‘capacity’ schemes

So-called “capacity mechanisms” are being set up across EU member states to remunerate power stations that remain on standby in case of demand peak. While a European framework is needed to regulate those schemes, Fabien Roques believes they should be adapted to local circumstances. reports.

In the meantime, the price EU countries are prepared to pay for keeping control of their national electricity system is not small. According to the European Parliament’s third Cost of non-Europe report, a more physically integrated internal energy market could deliver annual efficiency gains of at least €250 billion.

“It is a question of trust and cost,” Pollitt says.

“Are governments willing to pay to have that extra bit of political security? As long as those extra plants are cheap enough, the answer is yes.”

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