Capacity markets, where a central government decides how many power plants will be needed in a year’s time to meet demand, are archaic, easily evoking old images of Europe industrialising via coal power plants planned years in advance.
After years of liberalisation efforts, such markets now cover just 40% of the EU, holding on in countries like France, Poland, Italy, Belgium and Ireland.
But that number is set to surge as Germany, Spain and Sweden flirt with their own capacity mechanisms as politicians are lured by the promise of stable prices following the energy crisis.
Legal changes have followed them. The EU’s new electricity market design regulation says the archaic schemes can play an “important role”, unlike last decade, where capacity mechanisms were denoted as a “last resort” – only permitted to avoid a series of catastrophic blackouts.
“Capacity markets are really not going away, they are here to stay,” says Emma Menegatti, who researches the schemes at the European University Institute.
The problem: capacity markets are terribly unfit to address the main challenges facing the European electricity system – creating a more connected grid for the renewable transition while keeping prices down.
Among academics, the schemes are deeply unpopular.
“The history of capacity markets is littered with examples of failure to honour contracts,” the Regulatory Assistance Project (RAP) think-tank wrote in a report. Companies can choose to absorb a fine, making off with the profit from the mechanism.
The European Commission, tasked by the bloc’s new market deisgn with preparing the wide-scale revival of capacity markets by 17 April, has come to the same conclusion.
“Existing penalty regimes in capacity mechanisms do not always provide sufficiently appropriate incentives to actually guarantee delivery of the contracted service,” a new document published this week reads.
But the markets can be bad news for citizens, whether they actually deliver power or not.
Because by their nature, capacity mechanisms “risk institutionalising a bias towards excess capacity” as politicians fear blame for lacking capacity while “the cost [of overcapacity] is borne by consumers”, RAP explains.
The schemes then ultimately lead to “market foreclosure, determination of demand and favouring of individual technologies”, according to the European Energy Exchange (EEX).
Big, centralised and dispatchable power like gas, nuclear and hydropower are becoming the winners of Europe’s new capacity markets.
In 2023, 32% of EU capacity subsidies went to gas power plants, 24% to nuclear and 15% to hydropower, the Commission says.
“Incumbent companies as ‘traditional’ capacity providers are the main beneficiaries of the support,” the document adds.
That’s particularly bad news, since 15-year contracts are frequently standard, the RAP think tank points out.
Beggar thy neighbour
And in Europe, capacity mechanisms suffer from one more crucial flaw: they don’t work in the well-connected supergrid that the EU is building.
“The main issue we found is that if you are very interconnected and introduce a capacity market, then you will only displace generation from your neighbour,” said researcher Menegatti.
Because capacity markets subsidise electricity, power plants in neighbouring countries can’t compete. The virus spreads, as those countries need to set up their own capacity mechanisms to compete.
“Whether we are better off without any capacity market is not an easy question, but it’s certain that if everyone has one they will become quite costly,” she adds, given how governments can “easily overshoot demand” and end up wasting money.
A fix from last decade, cross-border participation in capacity mechanisms, has proven unwieldy and been largely unsuccessful, the Commission has acknowledged, citing Menegatti’s research,
These fundamental issues with capacity markets can be seen in practice.
The Polish capacity market fails to properly account for imports in its calculations and does not assume power plants will export power at all, EU watchdog ACER warned last month.
This could see power plant owners grow richer at the expense of taxpayers, while driving up power system costs all over Europe.
It remains to be seen whether Brussels, Berlin, Warsaw and others see the light in time before signing 15-year contracts with dozens of GW of coal capacity or expensive nuclear.
[BTS]
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