The current power market design applied in most European countries, which remunerates conventional plants for the electricity they sell, is becoming increasingly inadequate. Based on the rising contribution of renewable generation, wholesale power prices, generation spreads and the capacity utilisation of conventional power plants have been under considerable pressure in recent years. This has significantly reduced the operating profitability of conventional power stations and curtailed new thermal generation build in Europe.
As a result, the outlook for reserve margin adequacy post-2020 has deteriorated considerably in many European markets. Not only are new conventional generation plants not being built, but because of low wholesale power prices and utilisation, existing thermal stations are being closed or mothballed. Renewables do not represent stable and secure baseload generation capacity – therefore power systems are increasingly under stress as on windless and dark days, security of supply is threatened.
Based on the shortfalls of the current power market design, the UK government has decided to institute a significant change opting for the introduction of capacity payments. In such a capacity market, domestic power plants receive payments for guaranteeing reliable supply during times of peak electricity demand in winter. Capacity payments essentially compensate a power plant for contributing towards security of supply. A good analogy is how a fire service is remunerated; it is not paid for the amount of fires it deals with, but simply for the fact that it is there when needed.
The decision of the UK (third largest EU power market) to introduce capacity payments for domestic power plants from winter 2018/19, with the first auction taking place on 16 December 2014, marks a major development for the European utility sector. This significant change in power market design, which introduces a second major revenue stream for UK power plants next to the sale of electricity, will be studied closely by other European countries. This applies particularly to Germany (largest EU power market) and France (second largest), which are both looking at introducing capacity payments in power given their similar security of supply concerns.
Peter Crampton, utility and renewable energy research analyst, Macquarie