Capacity market: An answer to the risk of shortages in generation capacity

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Propositions set forth in the European Commission’s “Clean Energy for All Europeans” package are biased towards the model of a pan-European energy-only market, argues PSE.

PSE is the state-owned transmission system operator in Poland.

However, prices of electricity have ceased to effectively stimulate investments in generation capacity or decisions to withdraw them. This is so because development of RSE (renewable sources of energy) is supported by mechanisms that reduce fixed costs (and consequently, long-term fall of prices and their increasing volatility are observed), regulatory decisions are taken where maximum prices are taken into account, as well as due to instability of regulations and uncertainties of the market environment, which has led to the problem with ensuring adequate generation.

A solution that may be adopted to reduce the risk of a shortage of generation capacity is capacity mechanisms and in particular a capacity market. Therefore, EU regulations should not pose barriers to its creation and development.

On the contemporary energy market, the energy-only market as proposed by the European Commission is not efficient when it comes to maintaining generation capacities in operation and ensuring capacity reserves necessary for stable operation of the system.

The main reasons for this situation include, in the first place, instability of regulations regarding European capacity mechanisms and their environment, which makes it difficult to take long-term decisions.

Another problem stems from the fact that the current prices of electricity are distorted by the extensive use of non-market mechanisms to support RES technologies (in particular those reducing costs of entry that determine decisions on investing in RES).

Additionally, there are also non-economic factors such as price caps for energy offered on the market and uncertainty if abolishing such price caps and replacing them with VOLL (value of lost load) is possible and justified in social terms.

What is more, the scarcity pricing mechanism that allows for the possibility of significant rise in market prices under non-standard conditions (e.g. when demand is too high for the system capacity) is effective only provided that an emergency situation is about to arise due to technical reasons, which should be prevented from occurring by transmission system operators. As a result, the actual pressure for a price increase in the system will be still lower than that shown in the model presented in the CEP.

Distortion of prices and levels of generation occurring within the European market are transferred to countries that do not offer such grants. They distort investment decision related both to RES (that depend on grants), and conventional energy sources. This can possibly create a problem of insufficient generation that will grow more and more serious in line with the drop of profitability of baseload power plants.

Click here to read the full summary of PSE’s position.