recent developments in capacity remuneration mechanisms

Recent developments in Capacity

Remuneration Mechanisms

-Dilemmas in the EU-

Jean-Michel Glachant Director Florence School of Regulation

European University Institute (Florence, Italy)

www.florence-school.eu

The CRM dilemma in Europe

• Two conflicting goals:

Security of supply of electricity in Europe is challenged by climate policy and RES targets:

– Short-term flexibility required to cope with the variability introduced by intermittent RES,

– Long-term generation adequacy endangered by lower returns as a result of RES penetration, and decommissioning of conventional units.

Will market signals be sufficient to ensure security of supply?

• Two conflicting tools:

Capacity Remuneration Mechanisms are seen as a tool to ensure generation adequacy

… BUT the impact of national schemes on the internal energy market is not clear.

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Are we solving a current dilemma: security of supply vs. climate objectives? Are we creating a new one: capacity remuneration mechanism vs. IEM ?


The rationale for CRMs in Europe CRM in theory (1): The "missing money"

• Some “back-up generators” are only needed a few hours a year, at times of scarcity (no wind, no Sun, plant failures, high demand).

- BUT at times of scarcity, the network (and the market) collapse.

There is no way for “back-up generators” to receive scarcity prices through the market prices.

Some second-best tricks are used: prices are capped and reserves level are set administratively.

- BUT these prices are not high enough (political acceptability of high prices) and some of the actions taken by system operators are unpriced.

Scarcity rent reduced for ALL generators (not only peak units).

- And it is gets worse with intermittent RES as recovery (and pricing) at times of scarcity matters more for thermal generators displaced by RES and therefore running less often a year.

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NB. “Missing money” does not last as investors need a return => “Missing capacity”


The rationale for CRMs in Europe CRM in theory (2): The “missing planning”

• Market risks and the cost of capital (little merit)

= “Need to stabilize the revenues of generators and hedge against high volatility of prices so as to lower risks and costs of capital.”

- BUT prices volatility should NOT be an issue: oil refineries still get built.

- BUT(2) risk does not disappear, it is transferred to consumers and taxpayers.

• Political uncertainties and long-term coordination (more merit)

- “Will prices be allowed to rise ?” : Risks of ex-post market adjustments by policymakers

- “Who will provide a hedge against political risks ?” : e.g. no credible future markets for carbon price, while subsidies are not durable.

- Current irrelevance of the spot energy market to coordinate investments as strong policies drive the generation mix.

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If no credible market can be implemented, some form of long-term contracts are needed.


• What is needed is not capacity (as ‘steel in the ground’), but the ability to generate when and where needed.

• Current trend in Europe is to implement a simple CRM associated to complementary signals for short-term flexibility.

Can adequacy be conceived as separated from flexibility in a context of large-scale development of intermittent RES ?

How to define the adequate capacity product(S): standards or penalties if not available when needed ? What delay for availability ? Which cycling capability ? How many calls a month ? Which locational signals ?

• Definitions are not technology neutral!

- Demand response has a huge potential to take part into capacity markets and can bring huge savings, as seen in the US.

BUT design matters: it can respond very with very short-notice (Needed/Remunerated in CRM?) but cannot be available for one week (Needed/Penalized in CRM?)

- CRM timeframes (call 3/4 years before availability) often hardly compatible with the development of transmission assets.

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The rationale for CRMs in Europe: really ? Solving the missing money issue: which definition?


• Risks of seeing the government/TSO to become the consumer, with numerous uncertainties to handle:

– International negotiations for climate policy, RES targets, energy efficiency targets

– Market design: target model and cross-border infrastructures

– Technological game-changers: PV costs, Demand-side management

– General economic environment: demand growth, cost of capital

• Capacity markets are in any case heavily regulated and risks of miscalibrations are high. Design does not only determine how much we need, but which resources we need (New units? Clean Units? DSM? Transmission?)

Especially costly to commit too much capacity at times of: low demand growth/technology shifts/shorter lead time to build new plants.

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The rationale for CRMs in Europe: really ? Solving the missing planning issue: which implementation?

Do we really want to go back to central planning at times of high uncertainty? Missing money can also result from overcapacity: important not to compensate

overinvestment.


• Already a patchwork of capacity mechanisms in Europe

• Different needs and priorities lead to very different solutions.

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Individual CRMs and the IEM Probably not one harmonized CRM

Roadmap Priorities Challenges identified Mechanism

France 1/Affordability 2/Security of supply

- Increasing peak demand - Increasing share of RES

Capacity obligation on suppliers

Germany 1/Industrial opportunities 2/Security of supply

- “Missing money” due to RES - Closure of nuclear plants +

congestion in transmission network

“Transitory winter strategic reserve” in the South + Ongoing discussions

Netherlands 1/Affordability 2/Industrial opportunities

- No perceived need “Safety net” never used

UK 1/GHG mitigation 2/Affordability

- Closure of existing capacity - More intermittent & inflexible

generation Centralised auction

Source: Climate and Energy Roadmaps towards 2050 in north-western Europe (PBL)

Capacity Mechanisms in Northwest Europe (CIEP)

Unlikely that a common scheme can fit all.


• Barriers to trade

= “Does market coupling still make sense between neighboring countries with different capacity remuneration mechanisms ?”

YES, prices can be kept consistent in theory… and in practice (UK-Ireland) by distinguishing the energy remuneration from the contribution to generation adequacy

BUT there are obvious requirements, like opening these schemes to cross-border capacity.

Not so trivial: how to measure the contribution to security of supply of a unit in an other system?

• Investment distortions and capacity leakage

= “Any risk that states will compete for capacity by offering attractive remuneration schemes ?”

MAYBE, BUT not a problem if firm capacity is sold to the one who values it the most (See energy market coupling: the one who pays the most gets it all)

Emergence of a “coupled capacity market” will increase cost-efficiency.

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Individual CRMs and the IEM Will a patchwork of CRM endanger the IEM?

In coupled markets, there cannot be a pure national scheme for capacity remuneration, as energy prices are impacted by the situation in neighbouring countries. There will only be hybrid models based on: national capacity revenues + coupled energy prices.


• Reliability constraints are different in each member states:

– Different targets are in place:

E.g. max 3 hours/year of shortage in France vs. 10% capacity margin in Spain

– Different methodologies are employed to calculate contributions of a given unit to the system reliability (cross-border capacity, intermittent RES)

– Different practices exist to ensure security (Imbalance penalties for instance)

• Intermittent RES accounted for 70% of new installations in 2012, driven by renewable support schemes that differ (A LOT) in each country !

• There are still very different market arrangements: mandatory pool with low price caps and additional payments(Italy, Spain) vs. exchanges with high price caps (CWE, Nordpool).

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Individual CRM and the IEM There are many other sources of distortions

Many other sources of distortion exist in the EU, without preventing the implementation of market coupling. Common reliability methodology is more important than harmonised CRMs to ensure that a coupled capacity market can emerge.


Conclusion

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• The story is the following:

1/ No reason why a pure energy-market should not deliver the right signals and hedging possibility against price volatility, even in a fast evolving-environment

2/ BUT there are many interventions currently preventing the market from functioning properly

3/ SO a patch is needed: here come the capacity remuneration mechanisms.

European Commission focusing on solving 2/ [Guidelines on RES support; Towards a single greenhouse gas emission reduction target?]

BUT

Member States already moving towards 3/

The real issue: Will 3/ prevent 2/ ? Can 2/ be solved after a temporary 3/ ?

- The market can work with different national schemes. The main issue is not national capacity mechanisms, it is the way reliability is conceived in a national way.

- It is difficult to establish common reliability standards BUT there is a need for a common methodology to assess reliability.

www.florence-school.eu 11

Thank you for your attention Email contact: [email protected] Follow me on Twitter: @JMGlachant Read the Journal I am chief-editor of: EEEP “Economics of Energy & Environmental Policy”

My web site: http://www.florence-school.eu

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