New EU capacity market to reduce borders [NGW Magazine]

Stakeholders in the European energy industry have until August 9 to comment on a proposed set of rules for cross-border participation in capacity auctions. By July 2023 the latest, power generators in neighbouring countries will be allowed to bid into national auctions for the first time.

Capacity auctions are an important revenue stream for gas-fired power plants. They provide a fixed payment for plants that commit to supply electricity in the future. Recent auctions in the UK and Ireland, for example, illustrate this. In Great Britain’s T-4 auction for 2022/23 delivery, which took place in March, 27 GW of gas plant secured capacity payments. This was over 60% of the total awarded capacity. By comparison, only 1.3 GW of coal-fired and 4 GW of nuclear power secured payments. In Ireland and Northern Ireland, whose auctions are administered separately from GB, 7.8 GW of gas plants secured contracts in the T-4 auction in April, which was over 75% of awarded capacity.

The European Union’s Agency for the Co-operation of Energy Regulators (Acer) estimates that capacity mechanisms across Europe cost around €2.5bn ($2.8bn) in total in 2018 and that the figure for 2019 is probably higher. Most of the costs are passed on to end-users one way or another.

Gas plants look set to perform well in future auctions as the EU’s revised electricity regulation will make it harder for coal-fired plants to participate in auctions from 2025. In Italy, coal plants are already banned from participating.

Moreover, capacity mechanisms are seen as a prerequisite for new investment in combined-cycle gas turbines (CCGT) in many countries in Europe. Half of Belgium’s generation capacity is expected to go offline by 2025 when the last nuclear reactors at the Tihange and Doel plants are taken off the grid. CCGTs will replace a bulk of this capacity, but investors have made it clear that new-builds cannot go ahead before a capacity market is up and running.  

Engie, for example, wants to build a 870-MW CCGT plant at Vilvoorde in Flemish Brabant after acquiring the existing site and a smaller gas-fired plant from Bulgarian group EMBG in April. Belgium submitted its draft capacity market scheme to the European Commission (EC) in December last year but is still awaiting approval. The first auctions are planned for November next year if everything goes to plan.

Cross-border bidding

Cross-border participation will shake up the design fundamentals of national capacity markets. It means that power plant operators in neighbouring countries which are physically connected via interconnectors must be able to participate. For example, Dutch, French, Irish and Belgian power plant operators would be able to participate in the GB auctions since their markets are physically connected. GB plant operators will also be able to participate in French, Belgian and Irish auctions and so on.

This will be no mean feat. In fact, the revamp represents a minefield from an organisational perspective. A public consultation launched by The European Network of Transmission System Operators for Electricity (Entso-E) from January to March this year revealed that market participants and stakeholders have a number of concerns of how cross-border bidding will work in practice.

Revenue sharing, scarcity definitions, penalties, transparency and common methodologies are some of the sticking points.

Cross-border participation gives operators of gas-fired plants the opportunity to make additional revenues by bidding for contracts in neighbouring countries. Until now, only interconnectors have been able to participate in auctions. Come 2023, interconnectors such as the 1.4 GW BritNed interconnector between GB and the Netherlands and the 1 GW Nemo link with Belgium will have to share auction revenues with power plants, demand-side response (DSR) where major users can be paid for turning off their burners and energy storage operators in their respective countries.

“This sounds simple and logical but the arrangements to get there are complicated. It is a technical area,” Dan Roberts, a director at Frontier Economics’ energy practice told NGW.

“Another big question is how you work out penalties. How many times can a power producer sell its capacity into different markets? And if a power producer in another country fails on its contractual obligations to be available to deliver electricity, what price do you put on that?” he asked.

Security of supply

The EC has reluctantly approved a number of capacity markets over the last years owing to fears over security of electricity supply if unprofitable plants shut down. However, foreign cross-border participation was a prerequisite for these schemes to be approved in order to sustain the single electricity market and avoid “regulatory shopping” whereby investors overbuild in countries with benign support schemes. The EC only approved the French capacity market, for example, after Paris agreed to extend it to foreign participation.

GB, Ireland, France, Belgium, Italy and Poland all have capacity markets. GB and France have seen low settlement prices in recent auctions; a French auction in 2019 saw the settlement price hit €0/kW. The T-4 auction in the GB cleared at £15.97/kW/year. However, auctions in Poland, Italy and Ireland have fared much better. The Irish T-4 auction cleared at €46/kW while the most recent auctions in Poland cleared at around €57/kW and in Italy at €33/kW for existing capacity and €75/kW for new plants.

This should shore up investor confidence in new-build capacity including CCGT.

In Poland, for example, PGE’s planned 1.4-GW Dolna Odra CCGT plant won a 17-year contract in the country’s latest capacity auction which took place in December last year. Around 80% of generation in Poland is coal-fired but there are recent signs of gas switching. For example, Polish energy company Energa, which is to become part of PKN-Orlen in a major shift of state control, has announced that the planned 1-GW Ostroleka power plant will run on gas instead of anthracite if it gets built. Poland has interconnectors with Sweden, Lithuania, Ukraine and Germany so plant operators in these countries should be able to bid into the Polish auctions from 2023.

The design of capacity markets vary. In the UK and Italy, contracts with a duration of up to 15 years are offered. GB auctions were suspended for almost a year following a challenge by Timera Energy before the European Court of Justice where the claimant argued DSR operators were discriminated against because they could only bid for 1-year contracts. The court’s verdict – although not conclusive – put the UK government under pressure to redesign the scheme. Auctions resumed this year and DSR operators can now bid for 15-year contracts.

In Ireland, the duration of contracts is limited to 10 years and in France to 7 years. It is worth noting that French generators would be able to bid into the Irish auctions and vice-versa if the EU-backed 700-MW Celticconnector is commissioned by 2026 as planned.

Moreover, power generators in nations without capacity markets look set to greatly benefit. For example, gas-fired plant operators in the Netherlands should be able to bid into both GB and Belgian auctions even though there is no equivalent Dutch scheme. This is a sort of redress for Dutch gas-fired generators whose businesses were badly damaged over the last few decades by imports of cheap and subsidised renewable power from Germany.

Yet, in GB at least, the implementation process will be further complicated by Brexit. It is not a given that London will align its market rules for power and gas with that of the EU when the transition period expires.

“Brexit adds to the complexity of allowing cross-border participation in auctions. The future relationship in energy is far from clear,” said Roberts.

After the public consultation, Acer will review ENTSO-E’s methodology proposals and the feedback from stakeholders. It aims to make a final decision by October 3.