Ivanka Dilovska: Tackling risks to power supply security lie at the core of capacity payment mechanisms
Ms Dilovska, several European countries have introduced capacity mechanisms that are applied in parallel to the wholesale power markets. Can you explain to our readers what the reasons behind this are?
– There is a consensus on the current power market model. It does not promote investment in new capacities. Even more, several technologically viable conventional power plants have been closed down in the recent years, mainly due to financial deficits created by unsatisfactory market prices and declined involvement in power generation; they have been replaced by RES producers. It is expected that a new market model will remove these defects. This new model will be regulated by the Electricity Directive and Regulation which are part of the Forth Energy Package.
Investment activity deficiency in the last years brought risks to power supply security in Europe, mostly risks of power shortages in peak consumption periods or sharp drops in non-dispatchable renewable energy generation. That is why many Member States have gone ahead of the Forth legislative package adoption and have introduced capacity payment mechanisms, guided by the concerns about energy security because energy security is a responsibility of national governments. The same responsibility is equally valid for Bulgaria – here supply security is the responsibility of the Minister of Energy.
It is obvious that if there is an energy shortage that leads to supply interruptions, citizens will not accept the excuse that a new market model is expected from Brussels. Any discontent will, quite reasonably, be directed towards the responsible national institutions that failed to react and avoid risks in a timely manner.
To put it simply, capacity mechanisms guarantee certain level of security by paying producers for availability of generation capacity. This is in contract to the ‘pure’ energy market where power plants receive payments only when energy is generated but not when availability is maintained.
It is important to know that more than half of European countries apply such mechanisms. There are 33 different capacity payment mechanisms approved by the European Commission in accordance with the Guidelines on State aid for environmental protection and energy 2014-2020. For instance, only in February the Commission approved six new capacity payment mechanisms – in Germany, France, Italy, Greece, Belgium and Poland.
So, it is the risks to supply security faced by EU Member States that have prompted the elaboration of capacity payment mechanisms. Approval of such mechanisms means that the Commission regards assessment made by the submitting state as being credible with respect to both power generation adequacy and the need of additional capacity payments to maintain reliability standards.
There is much talk now about Maritsa Iztok 2 TPP salvation because it is a key capacity for the power system but faces serious hardships. In such situations EC approves capacity mechanisms. Can this happen in Bulgaria?
– Capacity payment mechanisms are not a salvation tool for any power plant. The rationale behind them is the predicted inability of the power system to provide a satisfactory power quantity and flexibility, guaranteeing reliable power supply at any given time. So, in order to have a capacity payment mechanism approved, ESO and the Ministry of Energy need to submit to EC convincing evidence and forecasts about system reliability deterioration. According to the wordings in the current draft Regulation, six months after adoption, ENTSO-E has to propose probability indicators about reliability as well as algorithms for indicator calculations to be applied by Member States and approved by national regulators.
Secondly, the mechanism itself, as laid down in the Guidelines on State aid, should be designed in a way to allow for inclusion of all actors that may contribute to problem solving – investors, producers, and operators, also from other Member States. Furthermore, again according to these Guidelines, sufficient number of producers needs to be involved to make sure the capacity price is competitive.
So, Maritsa Iztok 2 TPP would probably be one of the applicants in such a hypothetic competitive tender procedure, without this predetermining TPP’s selection. Besides, if technical and economic indicators in a TPP tender offer are equivalent to those proposed by another producer who has lower carbon emissions, then, according to the Guidelines, the other producer will be the preferred one.
On the other hand, if we take a look at ESO last ten-year plan for power transmission system development up to 2027 in Bulgaria, we will see that Maritsa Iztok 2 TPP has to remain operational throughout the entire ten-year period. The severe financial problems faced by the power plant will lead to its preterm closure, if relevant and timely measures are not undertaken. ESO should be aware of the impact such closure may have on system reliability. In case the impact is significant, as it is expected, the responsible institutions must have a solution to prevent such an outcome.
Can you explain the difference between capacity mechanisms and the current cold reserve?
– Capacity payment mechanisms differ by type and they are classified by their main characteristics. This classification has been elaborated by ACER. The current cold reserve is of the ‘strategic reserve’ type when certain capacities are maintained outside the market and are activated only in case of extreme circumstances under an order of national system operators. Payment is determined on the basis of competitive tender procedures. In contrast to the Bulgarian practice of determining the cold reserve on annual basis, other Member States normally run such procedures to cover a timespan of several years. Such type of mechanisms was approved for Germany and Belgium at the beginning of 2018.
Capacity tenders are yet another widely used type which essentially means setting up a capacity market. The capacity quantity required is identified centrally either by the system operator or the regulator, and refers to several years ahead. A clearing price is determined via a tender and this price then serves as basis for availability payments to all awarded tenderers (existing and new capacities). Such a mechanism was approved for the UK in 2014 and was the one with the longest application.
Another option encompasses the so-called interruptible load schemes where payments are directed towards consumers who accept to accommodate a decreased/increased consumption when instructed by the system operator to do so. At the beginning of 2018, EC approved such mechanisms for France and Greece.
Is it possible to introduce capacity mechanisms without increasing electricity price?
– If there is a well-functioning energy market where prices are not too low to secure investments in upgrading the existing capacities and building new ones, i.e. the so-called missing-money problem, then capacity mechanisms will not be required. It is only via accumulation of energy market revenues that sufficient money flows can be generated to fund not only operating but also investment costs, and respectively, to guarantee supply security.
However, in case the current energy market accounts for system operating costs rather than long-term investments required, it is only the capacity mechanisms that can secure such investments. They offer an additional money flow and an additional payment, and it is only logical to have it reflected in the electricity bills. For example, if a capacity market is introduced, the electricity bill can have an additional line called ‘capacity price’ similarly to the energy price. If we are talking about the ‘strategic reserve’ type, which is our case, costs incurred are included in the transmission price paid by all power grid users.
As indicated in ACER’s latest series of market monitoring reports capacity payments range from below 1% in Sweden to 33% in Ireland, calculated on the basis of the day-ahead price. In Bulgaria, payments are in the vicinity of 3%.
It is worth emphasizing though that provided power system reliability standards are identical, electricity price determined by both models – energy market and energy market plus capacity market – has to be comparable. Capacity payments do not increase electricity price mechanically, but rather secure the money flow required for investments and supply security when the energy market itself is impotent to do so.
Are these mechanisms going to disrupt the liberalized market?
– Energy industry representatives argue that Europe is in need of a smart design for the capacity market to guarantee supply security. At the other extreme are some MEPs that believe capacity payments are simply a different name for subsidies that disrupt the market and should be limited in time and scope. At the end of the day, truth lies somewhere in between – undoubtedly, capacity mechanisms are needed to secure supplies but they should be designed in a way to avoid competition distortion in the power markets.
There are three documents – Guidelines on State aid, Electricity Directive and Regulation – that define requirements for capacity mechanisms so as to prevent distortion of competition. Whenever Member States have concerns about their power systems, they need to undertake the following measures: first, to try and reform existing energy market making it more competitive and eliminating regulatory distortions and constrains; if the first step gives unsatisfactory outcomes, consultations with neighbouring countries should be initiated to look for a regional solution of the security issue and finally, if no regional solution is found, to embark on designing capacity mechanism that does not disturb existing market operations.
A pure energy market capable of a flexible response to energy shortages by providing sufficiently high prices that ensure investments in the long-run, remains to be the model Europe is striving for. In the meantime, however, the market model has been changed, and the notion of having a pure energy market will be carried over to a more distant future.
Is it possible to replace long-term power purchase agreements with such a mechanism?
– The market model applied in the country is a matter of political decision rather than of transforming these two agreements in particular. If a decision is made to introduce capacity market in principle, apart from the current cold reserve tenders, then these power plants can apply alongside other competitors, either domestic or regional, and become players on the new market. This could be made possible in parallel with their entry in IBEX platforms where they can sell energy.
We need to be aware that operating power plants with an emission factor over 550 g CO2/MWh, which is the case of our coal-fired power plants, will have a limited timespan regarding eligibility for capacity tenders. This issue is still discussed within the framework of the trilogue on the revised Electricity Regulation.
