Capacity Mechanisms in the EU Energy Market: Law, Policy, and Economics

Capacity Mechanisms in the EU Energy Market: Law, Policy, and Economics

Capacity Mechanisms in the EU Energy Market: Law, Policy, and Economics

Capacity Mechanisms in the EU Energy Market: Law, Policy, and Economics


Ensuring an adequate, long-term energy supply is a paramount concern in Europe. EU member states now intervene by encouraging investment in generation capacity, offering an additional revenue stream for conventional power plants in addition to the existing, heavily subsidised investments in renewable energy sources. These capacity remuneration mechanisms (or simply capacity mechanisms) have become a hot topic in the wider European regulatory debate. European electricity markets are increasingly interconnected, so the introduction of a capacity mechanism in one country not only distorts its national market but may have unforeseeable consequences for neighbouring electricity markets. If these mechanisms are adopted by several member states with no supra-national coordination and no consideration for their cross-border impact, they may cause serious market distortions and put the future of the European internal electricity market at risk. This book provides readers with an in-depth analysis of capacity mechanisms, written by an expert team of policy-makers, economists, and legal professionals. It will be a first point of reference for regulators and policy-makers responsible for designing optimal capacity mechanisms in Europe, and will be an invaluable resource for academics and practitioners in the fields of energy, regulation, and competition.


How to ensure adequate levels of generation capacity in the newly liberalized energy markets? Twenty years into energy market liberalization, Member States of the European Union (EU) start to question the ability of the so-called ‘energy-only’ markets, where generators are paid only for the energy they produce, to provide appropriate incentives to build new generating capacity in the right quantity, the right location, and based on the right technology. Why is there so little faith in market forces? Is not an optimal level of generation investments something that a liberalized and wellfunctioning market should provide?

A reply frequently heard from economists is that, in reality, truly free and competitive energy-only markets do not exist. A number of political/regulatory constraints, such as price caps, or operational barriers, keep prices for wholesale and balancing energy below their efficient levels at times when they should be high, providing insufficient revenues for gas-fired peaking units to recover their capital costs. The increasing intake of subsidized renewable energy into the system likewise depresses wholesale prices and drives higher-cost conventional plants out of business. However, as suggested by the diverging views presented in this book, there is still no consensus as to whether these concerns are valid or not.

And the common cure envisaged these days? Even more subsidies. We are witness to a hasty and uncoordinated introduction of so-called capacity remuneration mechanisms (or simply, capacity mechanisms) in a number of European countries. In essence, capacity mechanisms are just another form of state-driven support which compensates generators for their capacity, that is, their availability to produce energy at some point in the future. A more certain and stable stream of revenue for capacity, in addition to revenue from the sale of energy, is supposed to mitigate generators’ investment risk, encouraging them to build new power plants, and also to keep the existing ones in operation. Capacity mechanisms can also remunerate consumers for their commitment to reduce energy consumption at some point in the future. In this case, the mechanism supports investments in demand side response solutions. Capacity mechanisms are thus nothing more than a new regulatory ‘patch’ in the long transition towards a competitive, sustainable, and secure energy market the design of which still remains to be perfected.

But is not the cure worse than the disease—assuming there indeed is a disease? Capacity mechanisms may have serious implications for the completion of the European internal electricity market, the Holy Grail pursued since the mid-1990s. In particular, they might hamper cross-border trade and distort competition in the national day-ahead and balancing markets. They might also distort investment signals in the internal market leading to locational over- and/or under-capacity. As the economic rationale for introducing capacity mechanisms still remains uncertain, their actual impact on the performance of markets is even harder to establish. How would their introduction affect competition in spot markets? How would cross-border trade evolve? Would capacity mechanisms really boost new investments, as opposed to maintaining old and inefficient power plants on a financial drip? Would they optimize . . .

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