European Commission publishes final report on capacity mechanisms

On 30 November the European Commission published its long awaited Final Report on the capacity mechanism sector inquiry in the electricity market. The report is complemented by the “Clean Energy for All Europeans” package which will create a European legal framework for capacity mechanisms, introduce concrete rules for cross-border participation and lead to the integration of capacity markets. This new legal framework will clarify state aid assessment of capacity mechanisms by the Commission.

Capacity mechanisms are support mechanisms set up by Member States to fill the expected capacity gap and ensure security of electricity supply. Adequate capacity is needed to avoid black-outs and ensure that electricity supply meets demand at all times. Under such mechanism, capacity providers are offered additional rewards, on top of the income obtained by selling electricity, in order to maintain the existing capacity and such related investments. The Commission feared that such additional compensation might unduly favor particular producers or technologies and may create obstacles to electricity trade across borders, in breach of EU state aid rules.

This first ever sector inquiry in the field of state aid started in April 2015.  The Commission collected and assessed information from market participants and public bodies on existing and planned capacity mechanisms in 11 Member States.

The Final Report concluded that despite the fact that on an EU-wide level there is enough of electricity supply, some Member States still fear insufficient generation capacity. The Commission therefore recognizes that there might be a need for the capacity mechanisms, however points out that they need to be accompanied by appropriate market reforms. The Commission continues to describe its various market reform prepositions in the report. It also stresses that a need for such mechanisms must be demonstrated on the basis of a rigorous adequacy assessment against a well-defined economic reliability standard. If the assessment proves a need for such mechanism, the capacity mechanism should be open to all types of potential capacity providers through a competitive price-setting process, ensuring that not too much is paid for capacity. Market wide capacity mechanisms must also be open to explicit cross-border participation in order to minimise distortions to cross-border competition and trade, ensure incentives for continued investment in interconnection and reduce the long-term costs of European security of electricity supply.

The sector inquiry identified 35 past, existing or future capacity mechanisms in 11 Member States. The Commission observed that many of the current mechanisms have various shortcomings. The Commission will therefore continue its cooperation with Member States in order to improve the capacity mechanisms currently in place. Any future capacity mechanism will however need to be notified to the Commission as these mechanisms involve state aid and must be assessed under EU state aid rules. The Commission will examine in particular whether Member States have demonstrated the necessity of the proposed capacity mechanism and whether measures are in place to minimize the distortions of competition that they generate, taking account the guidance summarized in the Final Report of the sector inquiry.

As regards Germany, it currently has in place the network reserve, a strategic reserve and a further reserve based on lignite power stations. In addition Germany introduced a financial support scheme for existing combined heat and power capacities. This measure was approved by the Commission in November 2016 after Germany demonstrated that due to a higher level of production costs and low electricity prices, without the limited support, these plants would stop operating. Beside these measures, Germany has decided not to implement any additional capacity mechanisms. However, the new legal framework established by the Commission will provide a guidance on the future steps to be taken.