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Commission Staff Working Document of 30.11.2016 Accompanying the document Report from the Commission Final Report of the Sector Inquiry on Capacity Mechanisms {COM(2016) 752 final} SWD(2016) 385 final, p. 52
To help determine whether a measure or practice in a Member State qualifies as a capacity mechanism within the scope of this inquiry, the Commission has identified the following indicators. Capacity mechanisms:
- are generally initiated by or with the involvement of governments;
- have the primary objective of contributing to security of supply; and
- provide remuneration to capacity providers in addition to revenues they receive in the electricity market, or instead of revenues they could otherwise have received in the electricity market.
Commission Staff Working Document of 30.11.2016 Accompanying the document Report from the Commission Final Report of the Sector Inquiry on Capacity Mechanisms {COM(2016) 752 final} SWD(2016) 385 final, p. 52, 53
A particular area in which there may be debate about what constitutes a capacity mechanism and what requires State aid approval is in the specification and procurement of ancillary services.
TSOs typically procure frequency (balancing of the system) and non-frequency (voltage control and black-start) ancillary services to ensure the management of the system.
In most cases, they are mandated to do so by a general public service obligation to maintain system stability and security.
Where such ancillary services are procured independently by TSOs, and where in particular the determination of the precise volumes and types of services to be procured is left to the TSOs without Government involvement, there will be a strong indication that the purchase of such services does not involve State aid and that those services are therefore not covered by this inquiry.
Such indication will be strengthened when procurement of such services is performed in a transparent, competitive and non-discriminatory way, thereby excluding undue advantages.
Another element to distinguish ancillary services from capacity mechanisms is the use and purpose of the services: when they are used in small volumes relative to the overall level of capacity in the market and only to provide short term corrections to enable system security, they will more likely be considered ancillary services.
However, where ancillary services appear to be contracted at the request of governments and/or are used to ensure capacity is available to balance the system over longer periods, they can have the same effect as capacity mechanisms.
Such measures may merit attention from the Commission and require State aid approval.
Proposal for a Regulation of the European Parliament and of the Council on the internal market for electricity (recast), 30.11.2016, COM(2016) 861 final 2016/0379 (COD)
Chapter IV
Resource adequacy
Article 18
Resource adequacy
1. Member States shall monitor resource adequacy within their territory based on the European resource adequacy assessment pursuant to Article 19.
2. Where the European resource adequacy assessment identifies a resource adequacy concern Member States shall identify any regulatory distortions that caused or contributed to the emergence of the concern.
3. Member States shall publish a timeline for adopting measures to eliminate any identified regulatory distortions. When addressing resource adequacy concerns Member States shall in particular consider removing regulatory distortions, enabling scarcity pricing, developing interconnection, energy storage, demand side measures and energy efficiency.
Article 19
European resource adequacy assessment
1. The European resource adequacy assessment shall cover the overall adequacy of the electricity system to supply current and projected demands for electricity for a ten-year period from the date of that assessment, in a yearly resolution.
2. By [OP: six months after entry into force of this Regulation], the ENTSO for Electricity shall submit to the Agency a draft methodology for the European resource adequacy assessment based on the principles provided for in paragraph 4.
3. Transmission system operators shall provide the ENTSO for Electricity with the data it needs to carry out, every year, the European resource adequacy assessment. The ENTSO for Electricity shall carry out the assessment every year.
4. The European resource adequacy assessment shall be based on a methodology which shall ensure that the assessment:
(a) is carried out on bidding zone level covering at least all Member States;
(b) is based on appropriate scenarios of projected demand and supply including an economic assessment of the likelihood of retirement, new-build of generation assets and measures to reach energy efficiency targets and appropriate sensitivities on wholesale prices and carbon price developments;
(c) appropriately takes account of the contribution of all resources including existing and future generation, energy storage, demand response, and import and export possibilities and their contribution to flexible system operation;
(d) anticipates the likely impact of the measures referred in Article 18(3);
(e) includes scenarios without existing or planned capacity mechanisms;
(f) is based on a market model using, where applicable, the flow-based approach;
(g) applies probabilistic calculations;
(h) applies at least the following indicators:
– "expected energy not served", and
– "loss of load expectation";
(i) identifies the sources of possible resource adequacy concerns, in particular whether it is a network or a resource constraint, or both.
5. By [OP: six months after entry into force of this Regulation], the ENTSO for Electricity shall submit to the Agency a draft methodology for calculating:
(a) the value of lost load;
(b) the "cost of new entry" for generation, or demand response; and
(c) the reliability standard expressed as "expected energy not served" and the "loss of load expectation".
6. The proposals under paragraphs 2 and 5 and the results of the European resource adequacy assessment under paragraph 3 shall be subject to prior consultation and approval by the Agency under the procedure set out in Article 22.
Article 20
Reliability standard
1. When applying capacity mechanisms Member States shall have a reliability standard in place indicating their desired level of security of supply in a transparent manner.
2. The reliability standard shall be set by the national regulatory authority based on the methodology pursuant to Article 19(5).
3. The reliability standard shall be calculated using the value of lost load and the cost of new entry over a given timeframe.
4. The parameters determining the amount of capacity procured in the capacity mechanism shall be approved by the national regulatory authority.
Article 21
Cross-border participation in capacity mechanisms
1. Mechanisms other than strategic reserves shall be open to direct participation of capacity providers located in another Member State provided there is a network connection between that Member State and the bidding zone applying the mechanism.
2. Member States shall ensure that foreign capacity capable of providing equivalent technical performance to domestic capacities has the opportunity to participate in the same competitive process as domestic capacity.
3. Member States shall not restrict capacity which is located in their territory from participating in capacity mechanisms of other Member States.
4. Cross-border participation in market-wide capacity mechanisms shall not change, alter or otherwise impact cross-zonal schedules and physical flows between Member States which shall be determined solely by the outcome of capacity allocation pursuant to Article 14.
5. Capacity providers shall be able to participate in more than one mechanism for the same delivery period. They shall be subject to non-availability payments in case of non-availability, and subject to two or more non-availability payments where there is concurrent scarcity in two or more bidding zones where the capacity provider is contracted.
6. Regional operational centres established pursuant to Article 32 shall annually calculate the maximum entry capacity available for the participation of foreign capacity taking into account the expected availability of interconnection and the likely concurrence of system stress between the system where the mechanism is applied and the system in which the foreign capacity is located. A calculation is required for each bidding zone border.
7. Member States shall ensure that the entry capacity referred to in paragraph 6 is allocated to eligible capacity providers in a transparent, non-discriminatory and market-based manner.
8. Any difference in the cost of foreign capacity and domestic capacity arising through the allocation referred to in paragraph 7 shall accrue to transmission system operators and be shared between them according to the methodology referred in point (b) of paragraph 10. Transmission system operators shall use such revenues for the purposes set out in Article 17(2).
9. The transmission system operator where the foreign capacity is located shall:
(a) establish whether interested capacity providers can provide the technical performance as required by the capacity mechanism in which the capacity provider intends to participate and register the capacity provider in the registry as eligible capacity providers.
(b) carry out availability checks as appropriate.
10. By [OP: twelve months after entry into force of this Regulation] the ENTSO for Electricity shall submit to the Agency:
(a) a methodology for calculating the maximum entry capacity for cross-border participation as referred to in paragraph 6;
(b) a methodology for sharing the revenues referred to in paragraph 8;
(c) common rules to carry out availability checks referred to in point (b) of paragraph 9;
(d) common rules to determine when a non-availability payment is due;
(e) terms of the operation of the registry as referred to in point (a) of paragraph 9;
(f) common rules to identify capacity eligible to participate as referred to in point (a) of paragraph 9.
The proposal shall be subject to prior consultation and approval by the Agency under the procedure set out in Article 22.
11. The Agency shall verify whether the capacities have been calculated in line with the methodology as referred to in point (a) of paragraph 10.
12. National regulatory authorities shall ensure that cross-border participation in capacity mechanisms is organised in an effective and non-discriminatory manner. They shall in particular provide for adequate administrative arrangements for the enforcement of non-availability payments across borders.
13. Allocated capacities as referred to in paragraph 7 shall be transferable between eligible capacity providers. Eligible capacity providers shall notify any transfer to the registry as referred to in point (a) of paragraph 9.
14. No later than [OP: two years after the entry into force of this Regulation] the ENTSO for Electricity shall set up and operate the registry as referred to in point (a) of paragraph 9. The registry shall be open to all eligible capacity providers, the systems applying the mechanisms and their transmission system operators.
Article 22
Approval procedure
1. Where reference is made to this Article, the procedure set out in paragraphs 2 to 4 shall be applicable to the approval of a proposal submitted by the ENTSO for Electricity.
2. Prior to submitting the proposal, the ENTSO for Electricity shall conduct a consultation process involving all relevant stakeholders, national regulatory authorities and other national authorities.
3. Within three months from the date of receipt, the Agency shall either approve the proposal or amend it. In the latter case, the Agency shall consult the ENTSO for Electricity before adopting the amended proposal. The adopted proposal shall be published on the Agency's website at the latest three months after the date of receipt of the proposed documents.
4. The Agency may request changes to the approved proposal at any time. Within six months from the request, the ENTSO for Electricity shall submit to the Agency a draft of the proposed changes. Within a period of three months from the date of receipt of the draft, the Agency shall amend or approve the changes and publish it on its website.
Article 23
Design principles for capacity mechanisms
1. To address residual concerns that cannot be eliminated by the measures pursuant to Article 18(3), Member States may introduce capacity mechanisms, subject to the provisions of this Article and to the Union State aid rules.
2. Where a Member State wishes to implement a capacity mechanism, it shall consult on the proposed mechanism at least with its electrically connected neighbouring Member States.
3. Capacity mechanisms shall not create unnecessary market distortions and not limit cross-border trade. The amount of capacity committed in the mechanism shall not go beyond what is necessary to address the concern.
4. Generation capacity for which a final investment decision has been made after [OP: entry into force] shall only be eligible to participate in a capacity mechanism if its emissions are below 550 gr CO2/kWh. Generation capacity emitting 550 gr CO2/kWh or more shall not be committed in capacity mechanisms 5 years after the entry into force of this Regulation.
5. Where the European resource adequacy assessment has not identified a resource adequacy concern, Member States shall not apply capacity mechanisms.
Article 24
Existing mechanisms
Member States applying capacity mechanisms on [OP: entry into force of this Regulation] shall adapt their mechanisms to comply with Articles 18, 21 and 23 of this Regulation.
EFET commentary on the Clean Energy Package for All Europeans, 20 April 2017, 20 April 2017, p. 19, 20
We welcome the intention of the European Commission to establish rules in European legislation on capacity mechanisms. We support the provisions of Article 18 and 19 of the draft recast Regulation mandating Member States to perform a coordinated resource adequacy assessment at European level that should be the basis of any possible establishment of a capacity mechanism according to Article 23.5 of the draft recast Regulation. We also support Article 23.3 of the draft recast Regulation, which foresees that capacity mechanisms shall not create unnecessary market distortions and not limit cross-border trade and that the amount of capacity committed in the mechanism shall not go beyond what is necessary to address the capacity adequacy concern.
However, we believe that the final report of the sector inquiry on capacity mechanisms and the draft recast Electricity Regulation are quite a disappointment in terms of how capacity mechanism should or should not be designed, where they are deemed needed. We see no significant addition compared to the earlier publications of the European Commission on the subject since 2012. We were notably expecting a real “blue print” guidance for Member States in Article 23 of the draft recast Regulation to avoid the patchwork situation we are in at the moment with capacity mechanisms. This “blue print” guidance should include at least the following elements: all capacity mechanisms shall be open to cross-border participation; all capacities – all types of generation, demand or storage, existing or new – should be treated equally; mechanisms shall be designed to phase-out in case they are no longer necessary; the regulation should clearly state a deadline for compliance of existing mechanisms with the new rules.
A major novelty, and the only binding design criterion for capacity mechanisms that the European Commission has seen fit to include in the Clean Energy Package is a on greenhouse gas (GHG) emission standard in Article 23.4 of the draft recast Regulation. EFET rejects this concept as it contradicts the core principles of non- discrimination, effective competition and the efficient functioning of the market. A capacity mechanism needs to ensure security of supply – it is not a tool for promoting decarbonisation. The most efficient way to bring about decarbonisation is to internalise the externality of carbon emissions by putting a price on carbon. This is what the EU ETS seeks to do. Picking winners and losers through emissions limits is likely to introduce inefficient market distortions. To exclude specific technologies in this way may result in these technologies exiting the market and hence creating a requirement for costly new investment in (other) conventional power plants. Hence this measure is likely to bring no additional benefit in terms of emissions reductions while imposing higher costs on consumers. The measure will have the detrimental effect of weakening the carbon price in the EU ETS, which in itself undermines GHG reduction targets in the long-term. It will not reduce GHG emissions in the traded sector, since these are set by the EU ETS cap.
Somehow worrisome in the whole discussion on capacity adequacy is the lack of importance given to the relation between scarcity pricing and competition. Energy prices should be allowed to reflect the true value of scarcity during times of system stress and high demand for power; similarly, when energy is in abundance prices should be allowed to reflect the value of displacing that generation and even go negative. To this end we believe there should be no price caps or floors imposed on the market unless they are set at the value of lost load, as foreseen in Article 9.1 of the draft recast Regulation, without exception4. Making the market more efficient will result in a more efficient use of capacities and therefore translate into lower prices overall, which better reflect the match between supply and demand. We reiterate that assessments of capacity adequacy – to be performed at pan-European, or at least regional level – will remain inaccurate if the market framework in a specific country or region does not allow the free formation of prices.
Capacity remuneration mechanisms' taxonomy
pursuant to ACER's anaysis of of 30 July 2013 "Capacity remuneration mechanisms and the internal market for electricity"
Strategic Reserve
In a Strategic Reserve scheme, some generation capacity is set aside to ensure security of supply in exceptional circumstances, which can be signalled by prices in the day-ahead, intra-day or balancing markets increasing above a certain threshold level. An independent body, for example the Transmission System Operator ("TSO"), determines the amount of capacity to be set aside to achieve the desired degree of adequacy and dispatches it whenever due. The capacity to be set-aside is procured and the payments to this capacity determined through a (typically year-ahead) tender and the costs are borne by the network users.
Strategic or ring-fenced Reserves are essentially generating units that are kept exclusively available for emergencies (e.g. when the market is not able to cover demand) and are called upon by an independent body (e.g. the TSO).
The Strategic Reserve is intended to operate only when the market does not provide sufficient capacity and should therefore be dispatched at a price above a reference level signalling scarcity. In theory, the reserve should only be dispatched at a price close to VoLL in order not to interfere with the market even in tight conditions. In this case the natural price formation on the market is not affected and generators receive the same investment incentive as if there were no strategic reserve.
Capacity for Strategic Reserves is procured through a tendering procedure for a specified amount of capacity (in MW), for example on a year-to-year basis. The Strategic Reserve may consist of existing or - provided the auction takes place well in advance of when the contracted capacity should be available - new generation built for the purpose of reserve capacity and may include demand resources. The latter are normally obliged to reduce electricity consumption sufficiently fast to a specified level when called upon. The specification of the amount and type of capacity (e.g. peak units) or demand resources may be based on a so-called reliability study.
The compensation schemes for the providers of Strategic Reserves are specified in the tendering documents and may vary from case to case. These schemes may involve direct payments, payments in the form of an option or mixed forms. Strategic Reserve contracts contain also provisions for notification time, duration of activation, etc.
The costs of the Strategic Reserve schemes are typically covered through system charges included in the transmission tariff. Hence, they are passed on to consumers of electricity. In theory, the revenues, when dispatching the strategic reserves, should cover the costs.
Capacity Obligations
A Capacity Obligation scheme is a decentralised scheme where obligations are imposed on large consumers and on load serving entities ("LSE", further referred to as "suppliers"), to contract a certain level of capacity linked to their self-assessed future (e.g. three years ahead) consumption or supply obligations, respectively. The capacity to be contracted is typically higher, by a reserve margin determined by an independent body, than the level of expected future consumption or supply obligations. The obligated parties can fulfil their obligation through ownership of plants, contracting with generators/consumers and/or buying tradable capacity certificates (issued to capacity providers). Contracted generators/consumers are required to make the contracted capacity available to the market in periods of shortages, defined administratively or by market prices rising above a threshold level. Failure to do so may result in penalties. A (secondary) market for capacity certificates may be established, to promote the efficient exchange of these certificates between generators/consumers providing capacity and the obligated parties or between obligated parties.
The Capacity Obligation creates 'demand' and 'supply' for capacity guarantees. Large consumers and suppliers contract generation capacity corresponding to a certain margin above the volume of their expected consumption or supply obligations, respectively. The margin is applied on top of the consumers' or suppliers' own assessment future consumption/supply obligations. An independent body may set some assessment rules and determines the (reliability) margin.
Large consumers and suppliers can meet their Capacity Obligations by owning generation capacity, by obtaining bilateral contracts with - for instance - generators and/or buying capacity certificates. These capacity certificates are essentially contracts that specify the required availability of an electricity generating plant or part of an electricity generating plant (duration, notification time, etc.). Generators may sell capacity contracts up to the volume of generation capacity that they have reliably available, which is determined by an independent body. Also, demand side resources may be included as interruptible load contracts.
Capacity certificates offer flexibility in the way that large consumers and suppliers comply with their capacity obligation and, if they are standardised, they can be traded on a bilateral basis or in an organised market/auction. In the latter case, the certificate price is determined by the supply and demand in the market/auction.
Capacity providers are paid for the capacity certificates (or bilateral contract) issued; the suppliers pass on the costs of these certificates to their consumers.
Capacity contracted under capacity obligations is expected to be offered into the wholesale market and, in particular, in scarcity situations. Failure to make capacity available results in a penalty.
Capacity Auctions
A Capacity Auction scheme is a centralised scheme in which the total required capacity is set (several years) in advance of supply and procured through an auction by an independent body. The price is set by the forward auction and paid to all participants who are successful in the auction. The costs are charged to the suppliers who charge end consumers. Contracted capacity should be available according to the terms of the contract.
Capacity Auctions are similar to a Capacity Obligation scheme, though the capacity procurement process is centralised and an independent body acts on behalf of total demand. It calculates how much generation (interruptible load) capacity consumers/suppliers require based on the expected total peak demand. The calculations require reliability assessments, i.e. estimates of the total need for capacity including forecasts of peak demand and reserve margins.
Generators may sell capacity contracts up to the volume of generation capacity that they have reliably available, which is determined by an independent body. Capacity certificates can be traded. Suppliers include the cost of purchasing capacity credits in the price they charge to final consumers for electricity e.g. according to their off-take or off-take profile.
Capacity Auction schemes may allow generators and suppliers to procure capacity directly, as under a Capacity Obligation scheme, by means of owning generation, bilaterally contracting capacity. In this case they inform the independent body about their direct procurements outside the auction.
Reliability Options
Reliability Options are instruments similar to call options, whereby contracted capacity providers (typically generators) are required to pay the difference between the wholesale market price (e.g. the spot price) and a pre-set reference price (i.e. the "strike price"), whenever this difference is positive, i.e. the option is exercised. In exchange they receive a fixed fee, thus benefitting from a more stable and predictable income stream. Under a Reliability Options scheme, the incentive for the contracted generator to be available (at times of scarcity) arises from the high market price and from the fact that, if not available and therefore not dispatched, it will have to meet the payments under the Reliability Options without receiving any revenue from the market.
The holders of Reliability Options effectively cap their electricity purchase price at the level of the strike price, since whenever the market price increases above this level, the excess will be "reimbursed" through the payment made under the Reliability Options. A scheme based on Reliability Options usually rests on an obligation imposed on large consumers and on suppliers to acquire a certain amount of Reliability Options, linked to their (self-assessed) future consumption or supply obligations, respectively.
Different Reliability Options variants can be designed, depending on whether the scheme is purely financial or also involves an obligation to have and make capacity available when the option is exercised (or otherwise face a penalty). In this latter case the Reliability Options scheme becomes similar to a scheme based on Capacity Obligations.
The key idea of Reliability Options is to rely mainly on the financial incentives to ensure that capacity is bid into the market at times of scarcity.
In this mechanism, consumers - or an independent body on their behalf - buy Reliability Options. Contracted generators, who have issued Reliability Options, pay to the holders of such options an amount, for each unit of energy covered by the option, equal to the difference between the market price and a strike price, set administratively (e.g. by the independent body), whenever this difference is positive. In exchange they receive fixed revenues from the options issued and benefit from a more stable and predictable income. The mechanism may be purely financial, as just described, or a physical element may be included, by requiring contracted generators to make capacity available to the market when the market price exceeds the strike price. In this case a penalty (pen) may be payable, on top of the difference between the market price and the strike price, if the requirement is not met.
Consumers who hold Reliability Options 'implicitly insure' themselves against future electricity extreme purchasing prices (above the strike price). In fact, whenever the wholesale market price exceeds the strike price level, consumers effectively pay only the strike price, as the excess is compensated by the payment received from generators under the Reliability Options.
The volume of the contracts, the strike price and the penalty, if applied, are typically determined by the independent body. The volume of Reliability Options should be equal to the forecasted peak load plus a reserve margin, similar to the case of a Capacity Obligation mechanism. The strike price should be set well above the highest operating (marginal) cost of all units (reflecting a "near rationing" level) in order not to discourage any generator from producing. The level of remuneration for the availability of capacity to generators is in fact the price of the Reliability Options, which is determined on the market. Additionally, the time horizon (for example 7-10 years) needs to be set during which the seller may be required to make the committed capacity available when the market price exceeds the strike price.
Capacity Payments
Capacity Payments represent a fixed price paid to generators/consumers for available capacity. The amount is determined by an independent body. The quantity supplied is then independently determined by the actions of market participants.
The simplest type of capacity mechanism is to provide direct Capacity Payments. A direct Capacity Payment scheme encourages generators to invest in new or maintain old capacity by complementing the revenues that generators receive from the sale of electricity on the wholesale energy market.
The Capacity Payment is defined and controlled by an independent body. There are different methods of calculating the level of payments and how to target them. For example, the Capacity Payment may apply to all capacity or to existing generation plants only, to new plants, or to specific plant types. Alternatively, it can be differentiated between types of capacity, e.g. between base-load and peak capacity, existing and new capacity, etc.. Demand side resources are typically not eligible to capacity payments.
Generators who receive Capacity Payments for their plants sell their electricity on the wholesale market (i.e. electricity exchanges or bilateral contracts).
Capacity Payments may refer only to the present, but may also apply (exclusively) to new capacity. In the latter case, the payment is explicitly aimed at amplifying the investment incentives for new capacity.
The costs of Capacity Payments are covered by levies collected by suppliers. The fee is typically proportional to the amount of electricity supplied, usually in the form of an uplift charge on energy purchased.
Capacity remuneration mechanisms' taxonomy
pursuant to the European Commission's consultation document on generation adequacy, capacity mechanisms and the internal market in electricitygeneration adequacy, capacity mechanisms and the internal market in electricity (consultations ended on 07.02.2013)
Strategic reserves
The most basic capacity mechanism is a strategic reserve. Here capacity is procured, but kept for deployment in emergency situations generally by the transmission system operator. Often this reserve is made up of old plants which would otherwise be retired as uneconomical. The strategic reserve is withheld from the market or only bid into the market at extremely high prices. When it is dispatched by the transmission system operator during times of extreme scarcity it then also becomes the price setting plant meaning the strategic reserve effectively acts as a price cap in the market. Strategic reserves do not affect the market during normal periods and, because they are easily reversible, can be useful for supporting the transition away from fossil fuel based systems or facilitating nuclear phase outs.
Strategic reserves have interacted well with energy only markets where they have been used in Sweden and Finland, causing a minimum of distortion. Nonetheless, it is important that they be properly implemented – there must be clear rules as to when they can be deployed, in particular they should not be used to keep prices low, which could result in high emissions from inefficient old plants and discourage the development and deployment of new and more efficient technologies, including storage and demand side response. It is also important that such strategic reserves not be established in such a way that they reinforce the position of incumbents.
Capacity payments and markets
Other capacity mechanisms target generation capacity which continues to participate in the normal energy market. There are several varieties of such mechanisms:
(1) a capacity payment which is a fixed price paid for available capacity or
(2) a capacity market where either: (a) the required quantity is centrally fixed and procured, for example by the transmission system operator, or (b) based on their customer profile, suppliers are obliged to buy an administratively determined quantity of certified capacity from generators on a market parallel to the normal energy market.