Can Capacity Markets be the cure to reaching emissions reduction targets?

 Johan Ingberg, Manager at PBI

Capacity Markets (CMs) is an increasingly popular policy measure being considered in European electricity markets with the aim of securing electricity supply at the lowest cost to consumers as well as supporting new investment into power generation assets. In the UK, it is already up and running and constitutes a key part of their Electricity Market Reform program. Similar auction-based Capacity Markets are being formed in Ireland, France, and Italy.

Ambitious emissions targets will require immense investment

In the EU’s 2030 Climate and Energy framework, the target is set to cut greenhouse gas emissions by at least 40% compared to 1990 levels and by 80% by 2050. CO2 emissions account for roughly 80% of all EU greenhouse gas emissions. Furthermore, at least 27% of our energy should come from renewables while existing energy production should see a 27% increase in efficiency.

These targets put a lot of pressure on the power sector. New, clean power investments are needed and at the same time, old polluting power plants need to be shut down. When the framework was adopted by EU leaders in 2014, it included a projection of capital needed to reach the targets. The average annual required investments were projected to an amount of €38 billion for the EU, over the period 2011-30.

The UK leading by example

In 2015, as the first country in the world, the UK announced a total phase-out of coal. This would be achieved by 2025.  8GW of coal fired electricity generation capacity had already closed since December 2012 due to the Large Combustion Plant Directive (LCPD). A total of 19 GW coal fired capacity still existed and that capacity needed to be replaced with new capacity, preferably from renewables.

Figure 1 The UK coal phase-out scenarios according to National Grid’s FES report 2017

At the same time, the UK announced the roll-out of a so-called Capacity Mechanism (CM) subsidy scheme. Its function was to ensure new, greener investments in power generation in the UK, enabling the phase-out of coal and other fossil fueled power plants without increasing the risk for blackouts.

The first CM auction was held in 2014 and was called the T-4 auction. The “T-4” means that any subsidy agreements secured, will come into force four years after the auctions is closed; 1-year agreements for existing units and up to 15-year agreements for new builds. So far, these T-4 CM auctions have been held annually, amounting to four in total. So far, a total of 10,9GW new build units have been able to secure 15-year capacity agreements, enabling a structural change in the UK power market. An important thing to notice is that wind and solar power, are not able to take part in the CM auction.

Figure 2 Split between existing and new build units in the last four auctions (MW)

Aftermath: Do we even need capacity mechanisms?

Although 10,9GW of new build power generation has been secured, there has also been some criticism against the CM. Already after the first CM some critics claimed/noticed that the needed change to a greener power sector is actually slowed down by these agreements. This is because existing, inefficient and polluting power plants can also be awarded CM subsidies, and effectively their lifetimes are prolonged (albeit for only 1 year at a time) instead of being forced to shut down due to uneconomical power production.

Another source for criticism is the fact that solar and wind energy producers are not allowed to take part in the auction. This was firstly due to that the auctions were only allowed for dispatchable power plants, meaning power generation which can be turned on and off voluntarily (which solar and wind inherently can't), and secondly that they were already reaping benefits from other subsidy schemes. However, according to some industry analysts, subsidy-free renewables will eventually be able to kill off prospects for new dispatchable power stations. The falling costs for solar and wind projects, combined with advances in battery storage will bring investments to up to £20bn between now and 2030 in these technologies.

The Capacity Market can still be seen as one way to induce restructuring of the energy markets in Europe. The emissions reduction targets set up in Europe are “a political decision”, and at the time of these decisions, the cost structure for different technologies looked very different than today and in the future. The CM can help to fill the gap created and to get past a transition period. In the near future, renewables will become so price competitive that they will require no subsidies at all. Solar and wind will then begin to function as (intermittent) base load together with nuclear and interconnectors throughout Europe and storage and natural gas-fired peaking plants will take the stress of the grid during peak times.