Capacity mechanisms reform – key issues to watch

Probably the most hotly contested issue is a proposal to ban capacity payments for power plants emitting more than 550g of CO2 per kilowatt hour. [Vikramdeep Sidhu / Flickr]

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

The European Commission wants to limit state aid for power plants that EU countries remunerate to remain on stand-by in case of demand peak. As negotiations on the EU’s new electricity market enter the home straight, EURACTIV lists the main issues to watch out for in the debate.

The European Commission has made no secret of the fact that it would prefer to see an “energy only” market-based electricity system. In the Commission’s view, capacity mechanisms are, at best, a necessary evil during the EU’s transition to a cleaner energy system.

The EU executive’s competition directorate recently approved a raft of national capacity schemes, after a thorough probe into their legality under the bloc’s state aid rules.

But the fate of such national programmes, which remunerate generators for keeping conventional power plants on line, now hangs in the balance, as lawmakers lock horns over a proposed new Electricity Regulation and Directive.

If it gets its way, the EU executive would severely limit the opportunities for governments to resort to such schemes, while some existing capacity mechanisms would be forced to adapt or close.

Here’s a breakdown of the main issues in the debate.

CO2 constraint: The 550g/KWh question

This is probably the most visible and hotly contested issue. In its proposal for a Directive on wholesale electricity market design, the Commission has sought to deal with the concerns over shoring up the finances of coal-fired plants.

Although the proposed CO2 emissions limit of 550g per kilowatt hour met stiff resistance from several countries – led by Poland – it has been retained in the amendment proposals adopted by both the European Parliament and the EU Council.

However, the devil is, as always, in the detail. The widely different effects of small print proposed by the two legislative bodies could dramatically alter the impact of the new wholesale market rule book on both existing and planned capacity mechanisms.

Parliament wants a different limit for schemes designated as ‘strategic reserves’ – a system that Germany, for example, is using to keep some coal plants available for emergency use amid a gradual process of decommissioning.

In such cases, the emissions standard would be 200kg of CO2 per year for each kW of generation capacity made available, effectively limiting the time such plants could run. Meanwhile, the Council says inclusion in capacity schemes – of any type – should be limited to plants “emitting more than 550 gr CO2/kWh of energy or more than 700 kg CO2 on average per year per installed kW”.

The parliament’s proposal would limit the time that typical lignite-fired power stations, the heaviest emitters of greenhouse gases, could run as part of a strategic reserve, to around 200 hours a year. Under the corresponding Council proposal, that figure would rise to 700 hours, or roughly a month of operation, for power stations in any type of capacity mechanism.

One idea gaining traction is to allow all forms of electricity generation to participate in capacity mechanisms, including coal-fired plants. But instead of limiting the number of hours they can run, regulators are now contemplating limits on the total amount of CO2 they can emit in a given year.

At the end of the day, “what matters is the number of tonnes of CO2 emitted,” said Virginie Schwarz, the energy director at the French ecology ministry who addressed a webinar hosted by the Make Power Clean campaign, a business coalition.

Poles reject ‘totally unacceptable’ EU power market reform

A phase out of government subsidies for coal power, supported by the European Parliament under a proposed revision of EU electricity market rules, was rejected by the Polish power sector as a reflection of “double standards” in Europe because it leaves German coal plants largely off the hook.

Legal certainty, exemptions and timing

The European Commission proposes that the CO2 emissions limits should apply immediately to new power plants, and from 2025 in the case of existing generation facilities.

However, this is likely to be softened with temporary exemptions and a phase-in period. Where to draw the line is going to be tough as lawmakers comb hundreds of pages of sometimes highly technical jargon.

One example is a paragraph that national governments have introduced in their ‘general approach’ to the market design proposal, stipulating that new EU laws should be “without prejudice to commitments or contracts” concluded before entry into force of the EU’s new regulation.

This would mean the numerous state aid schemes already in place – in Poland, Germany and elsewhere – would not have to comply with the proposed emissions limits and other rules, according to Roland Joebstl, an activist at the European Environmental Bureau (EEB). “This is huge – it’s not even a loophole, it’s more like a tunnel making most of the provisions next to useless,” he said.

In fact, what happens to existing contracts and EU state aid decisions is still under discussion. Poland is pushing hard to obtain “grandfathering” rights for EU state aid decisions that have already been made, saying it is a matter of “legal certainty” for companies which have already passed contracts under the Polish scheme.

Polish energy firms have asked a ten-year “derogations for existing installations” in order to give sufficient time for Poland to adjust its energy mix.

The Council of European Energy Regulators (CEER) has echoed national concerns regarding the status of existing contracts. In a white paper last year, it warned that, while “commendable” in principle, the Commission proposal “does not provide a clear framework to ensure compliance of existing mechanisms with the future regulatory framework.”

EU admits 'mistake' in state aid decision for German coal plants

The EU’s decisions to approve state support for emergency power plants in France, Germany, Poland, Italy and Greece will all have to be revisited in light of the ongoing reform of electricity market rules, the European Commission said on Tuesday (4 September), saying it won’t make an exception for Germany.

Sovereignty: Who decides?

Capacity mechanisms are essentially national interventions that go against the grain of EU free market rules. They are only permitted under EU state aid guidelines in cases of demonstrable need – in short, when there is a risk of the light going out.

But who should decide on the necessity of a capacity scheme in a given member state is a matter of fierce debate. At its very basis, the decision is informed by an “adequacy assessment” to evaluate whether there is enough supply to meet demand at all times, including during peak hours.

The Commission wants this done under the auspices of the transmission systems operator body ENTSO-E, with oversight from the European energy regulator ACER (itself at the centre of a fractious debate over increased powers and national sovereignty).

State governments see it differently, and insist on a national adequacy assessment to take place alongside the European one.

Which one should prevail in case of conflict is still up for discussion, however.

In the Council, reservations were clearly voiced by seven EU countries – France, Italy, Poland, Hungary, Greece, Ireland and UK. In a position paper, the group argued the outcome of a European adequacy assessment should not be the deciding factor in whether a capacity mechanism can operate, as governments have a “fundamental responsibility” to ensure security of supply.

“As such it should ultimately be for them to determine whether it is necessary to introduce a capacity mechanism within their own market, as well as to decide on the most appropriate and proportionate form of mechanism to address the adequacy concern, all subject to state aid approval,” they wrote.

ENTSO-E itself actually believes the European assessment should not replace national ones, arguing those “will continue having better granularity”.

Green lawmakers, for their part, have misgivings about leaving the decision in the hands of national governments. “The adequacy assessments are crucial, as the conclusion will decide the deployment of a capacity mechanism in a given country,” said Florent Marcellesi, the Greens/EFA group’s lead negotiator on the market reform.

“The problem with doing this at the national level is there is a risk of having very little transparency,” he argued. “The assessment could easily be manipulated to allow for a capacity mechanism,” Marcellesi warned.

Adequacy assessments matter because they will guide decisions on how to finance investments in the long run and address the “the missing money issue” identified in the Commission’s sector inquiry. Energy companies fear a “‘stop-go’ phenomenon” that would spook investors and undermine long-term supply security objectives.

Regional assessments have been suggested as a potential solution. But although important and “worth looking forward to” they are currently not sufficiently reliable for governments to make a decision, said Virginie Schwarz, director for energy at the French ecology ministry.

At the end of the day, the methodology used to calculate adequacy might actually be more relevant than whether assessments are made at EU, regional or national level, she said.

Capacity markets: How much ‘flexibility’ for EU countries?

Mostly out of pragmatism, the European Commission has adopted a rather tolerant approach to “capacity mechanisms” – national schemes that remunerate back-up power plants – accepting that EU countries face different challenges in the energy transition.

Reaching across borders

A related question is whether cross-border interconnections should be taken into account when deciding whether an EU member state can set up a national capacity mechanism.

“Explicit participation of cross-border capacities can be an efficient way to ensure the desired level of security of supply at the minimum cost for consumers,” the Council of European Energy Regulators said in its white paper.

This would mean member states taking into account all possibilities for importing electricity when national generators cannot cover demand peaks domestically. If a neighbouring country has an excess of generation capacity – as several EU countries do – a member state would have to take into account the potential for imports via high voltage power lines before they could resort to setting up national capacity mechanisms or strategic reserves.

The electricity industry association Eurelectric argues that existing market-based capacity mechanisms can themselves act as a tool for adequacy assessments by explicitly putting a value on generation capacity. “For instance, if enough capacity is economically viable in the system and able to ensure the adequacy target, the capacity price will tend towards lower levels,” the industry group said.

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.

Time-limits: A sunset clause in the transition?

National governments claim capacity mechanisms provide vital back-up power in the transition to higher shares of intermittent renewable electricity. “It gives them the confidence of having backup capacity when wind and solar are not available,” according to 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.

In that sense, capacity mechanisms “may be the price to pay” for renewables, Pollitt argues, saying they will be phased out eventually, when the coal phase-out is completed and the share of renewable electricity has risen.

The European Commission is wary of limiting the transition phase, however, and imposed a number of constraints, such as time limits. Critics argue long-term contracts can create a lock-in effect that keeps polluting plants in the system longer than necessary.

But supporters claim long-term certainty is precisely what investors need to address the supply security concerns that capacity markets were aimed to address in the first place.

Some argue they could even become more of less permanent, saying well-designed capacity markets can stimulate clean energy, cross-border interconnection, and “flexibility” services. In France and Greece for instance, capacity markets were specifically designed to incentivise demand-response technology, which helped offset the unavailability of thermal, nuclear and conventional capacity.

“Regardless of whether there are market failures in energy markets, introducing a capacity mechanism is a no-regret option,” argues RTE, the French transmission system operator. “A properly designed capacity mechanism not aiming for overcapacity systematically leads to social welfare improvement,” it argues.

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.

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