In a perfect electricity market, the energy available in the system would fully satisfy consumer demand every hour of every day. In reality, however, there are times when the energy supply in the system is insufficient to meet demand. When this happens, there are power plants on standby that are activated to generate additional energy. To ensure that these plants keep their facilities ready to operate in the event of a supply and demand imbalance, support schemes known as capacity mechanisms are introduced.
What are capacity mechanisms?
In more technical terms, a capacity mechanism is a measure designed to ensure resource adequacy, i.e. the ability of electricity resources to meet demand, taking into account demand forecasts, availability from generators and transmission constraints.
Paying facilities just for existing may sound strange, but it is essential to ensure a stable flow of electricity and avoid interruptions in electricity supply from generation. This is even more important for Europe’s evolving energy system. With Europe’s transition to net-zero emissions, these imbalances between supply and demand are expected to increase due to the growing share of renewable energy production. By 2030, solar and wind energy are expected to account for almost 54% of total electricity production in Europe, rising to 71% by 2050.
When the sun is not shining and the wind is not blowing, such mechanisms serve as insurance for the energy system and the European economy as a whole, ensuring better security of electricity supply and preventing power outages and consumer power cuts, as shown by Eurelectric’s study on energy security.
How does the capacity mechanism work?
Capacity mechanisms reward energy resources for their available capacity, usually through long-term contracts. These measures are classified as state aid. As such, they are agreed at national level and require the approval of the European Commission’s Directorate-General for Competition.
Traditionally, the main targets of these measures have been nuclear, gas and coal-fired power plants, as they are dispatchable resources. Today, these mechanisms are increasingly being extended to cover hydropower, storage and flexibility offered by the consumption side.
What are the benefits of the capacity mechanism?
Today, capacity mechanisms are one of the main tools for:
– Ensuring energy security: capacity mechanisms have become a key tool for security of supply in Europe, as the number of peak power plants – those used only to meet peaks in electricity demand – is declining compared to growing renewable energy sources;
‘The level of dispatchable capacity is expected to decline by 40% by 2050 as we decarbonise the energy system,’ said Nicholas Leach, energy economist at Aurora Energy Research, at an event organised by Euractiv.
– Meeting flexibility needs: capacity mechanisms can also provide system flexibility by rewarding firm and flexible capacity to balance variable renewable energy generation;
– Lower capital costs: the existence of a capacity mechanism provides clarity for investors and helps reduce capital cost risk;
– Contribution to system resilience: the mechanism can also help the system limit the extent, severity and duration of system deterioration following an extreme event.
Where are capacity mechanisms approved?
Capacity mechanisms exist around the world and are growing in popularity. The first mechanisms appeared in the early 2000s within the US electricity system and the Unified Energy System of Russia. Since then, more than twenty countries have adopted capacity mechanisms. In 2020, they will cover ‘around 40% of installed energy capacity in the US, 50% in South America and 80% in Europe,’ according to Renewable and Sustainable Energy Reviews.
EU electricity markets have historically been based on a market structure model for energy only, but many countries have found it necessary to introduce capacity mechanisms to support investment and ensure the level of security desired by policymakers.
As in 2022, eight Member States had active capacity mechanisms in 2023: Belgium, Ireland, France, Italy and Poland implemented market-wide capacity mechanisms, while Germany, Finland and Sweden implemented strategic reserves, according to ACER.
Strategic reserves, capacity markets and capacity payments are therefore the main types of support measures adopted in Europe.
What is the difference between a strategic reserve, a capacity market and capacity payments?
Strategic reserves were the first mechanisms introduced by countries to keep traditional power plants – mainly coal and gas – open in case their capacity is needed for adequacy reasons. Such reserves are located outside the electricity market and are paid for by the central system.
They are targeted at specific power plants, but there is a risk that countries will activate them too often, as they can be used not only to manage resource adequacy but also to reduce high prices. This has led to market distortions and reduced the economic benefits of those energy resources that are not included in the reserves.
To avoid such abuses, capacity markets have been introduced. In a capacity market, all technologies can participate through competitive bidding. Even resources from neighbouring countries can now participate. The market participant with the best offer receives a fixed remuneration for its fixed capacity.
Finally, capacity payments are administratively determined payments whereby the central authority can pay all or some market participants for their fixed capacity.
How has regulation of capacity mechanisms evolved?
Public opinion on capacity mechanisms has changed significantly in Europe, especially since the energy crisis of 2022-2023. The following three documents reflect the evolution of the EU’s understanding of capacity mechanisms:
State Aid Law
Capacity mechanisms became more widespread in Europe a decade ago. In 2014, the EU decided to regulate capacity remuneration through state aid legislation under the supervision of DG Competition to ensure that these measures do not create risks to competition and trade.
According to Article 107 of the Treaty on the Functioning of the European Union (TFEU), “any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods […] shall be incompatible with the internal market.‘ However, the same article allows for exceptions where aid is granted to ’facilitate the development of certain economic activities, where such aid is not contrary to the common interest.”
As this exception remains rather unclear, in 2022 the Commission decided to narrow the definition of the energy sector in the Guidelines on State aid for climate, energy and the environment (CEEAG). These guidelines apply to state aid supporting the development of economic activities that also improve environmental protection and promote the security of electricity supply, thereby including capacity mechanisms.
The high level of abstraction of State aid creates challenges for harmonising these measures beyond the national level. However, these rules have long been the only means of controlling the adverse effects of capacity mechanism projects. The EU’s Clean Energy for All Europeans package sought to change this by adopting specific rules on resource adequacy.
The 2019 Clean Energy Package
The 2019 Clean Energy Package emphasises the need to limit the misuse of capacity mechanisms, giving priority to the market for energy only and considering capacity mechanisms as a last resort to ensure resource adequacy.
In order to activate a capacity mechanism, Member States must demonstrate the existence of an adequacy problem through a rigorous assessment. Before resorting to the capacity mechanism, countries are required to present a plan to address the root causes of the problem through market reforms.
‘This requirement reflects the recognition that markets, if well designed, free from regulatory distortions and sufficiently connected to the EU electricity network, can provide the necessary quantity and type of capacity to meet any demand,’ says the European Commission.
However, if this is not sufficient, countries may resort to strategic reserves and, as a last resort, to capacity markets.
Another requirement introduced by the package is to allow foreign resources from neighbouring countries to participate in the capacity mechanism, a concept known as cross-border participation.
The 2023 electricity market structure reform.
The energy crisis of 2022-23 changed the rules of the game for capacity mechanisms. The price crisis triggered several market interventions, disrupted the business cycle and investment in new capacity.
The very foundation of the energy market was called into question. As concerns about Europe’s energy security grew, scepticism towards capacity mechanisms changed. Markets with investment guidance became the preferred option over no markets at all.
The reform of the EU electricity market design thus made capacity mechanisms a structural component of the electricity market and a key tool for ensuring security of supply in Europe, and called for the approval process to be accelerated.
Framework for State aid for a clean industrial deal from 2025
In March 2025, the Commission reviewed the existing capacity mechanisms and published a proposal to speed up the authorisation process and harmonise the design parameters of European markets.
This proposal is known as the Clean Industrial Deal State Aid Framework (CISAF).
While the CISAF could lead to greater convergence in Europe and ensure a faster approval process, the requirements should minimise distortions and take into account the different needs of systems. In response to the public consultation on the CISAF, Eurelectric proposed:
– taking into account a more detailed assessment of the different needs of the energy system at national level: The draft CISAF relies heavily on the European Resource Adequacy Assessment (ERAA). However, national resource adequacy assessments should also be used in the selection of projects, assessment reduction factors and other parameters, ensuring that the specific characteristics of national systems are fully taken into account.
– Improving the proposed cost allocation methodology: With the proposed methodology, the costs of capacity mechanisms could be allocated to hours with high prices without placing any real strain on the electricity system. Instead, Eurelectric proposes that stress periods be defined in advance.
– Assessing joint procurement of adequacy and flexibility on a case-by-case basis: The draft CISAF could lead Member States to award joint contracts for flexibility and adequacy by default. Instead, the need for joint procurement should be assessed on a case-by-case basis, reflecting the specific conditions of each national system.
Current state of capacity mechanisms
Currently, capacity markets are in place in one third of European countries, strategic reserves are used in another third, and the remaining third rely solely on energy markets. In 2024, capacity markets provided 1,793 GW, with one third of payments going to clean technologies and storage technologies.
Barriers to capacity mechanisms
Today, there is no common vision at EU level on how to ensure security of supply. Many EU countries have introduced capacity mechanisms to support investment in stable and flexible technologies and to provide the level of security desired by policymakers. However, this has led to a patchwork of approaches across Europe with reduced harmonisation, creating barriers to effective cross-border participation.
Lack of harmonisation in the design of capacity mechanisms
Assuming that the Market Structure Reform has opened capacity mechanisms to all new and existing technologies, there is still no common vision for their design. The capacity mechanisms implemented so far have a number of shortcomings, such as:
– barriers to the full participation of all types of capacity in capacity mechanisms in Europe, creating an uneven playing field;
– impeded cross-border participation in most capacity mechanisms;
– Incorrect signals to consumers, as the costs of the mechanisms are usually passed on to consumers through a “fixed” fee for the entire year of delivery and do not reflect periods of peak demand and shortages – which correspond to the periods for which the assets are contracted as part of the capacity mechanism.
Forgetting flexibility
Furthermore, the current design of the capacity mechanism focuses on capacities providing adequacy services without assessing their contribution to flexibility needs. As the need for system flexibility in Europe will increase significantly, it may be necessary for the contracting mechanisms to assess the contribution to flexibility to ensure that system needs are met. Joint procurement should therefore be assessed on a case-by-case basis.
Long approval process
State aid authorisation requires a complex and uncertain process that has not yet encouraged strong harmonisation and coordination. Currently, the approval process typically takes at least six months, but according to the Commission, the pre-notification period can be as long as two years. The latter period includes all early discussions with Member States when the scheme is still under development. This includes several rounds of exchanges with national stakeholders and the Commission services to ensure that the relevant draft capacity mechanism is in line with EU legislation.
5 important adjectives for a well-designed capacity mechanism:
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- Market-based: capacity remuneration should be competitive so that prices can move freely without price distortions;
Technologically neutral: all sources providing firm capacity should be able to participate in the market without discrimination.
- This includes generation technologies, but also demand response and storage.
- Open to new and existing assets: market access should be based on a level playing field between new and existing providers of firm capacity.
- Cross-border participation: capacity mechanisms should be open to cross-border participation in order to encourage regional cooperation, taking into account regional interdependencies.
- Encouraging negotiation: capacity mechanisms should result in capacity contracts, not just regulatory commitments.
Much remains to be done to improve these schemes, harmonise them across Europe and ensure that they cover all sources of permanent capacity. But one thing is certain: capacity mechanisms are here to stay.
Source: Eurelectric
