COLUMN-Capacity payments clash with EU single energy market:Wynn

Wed Oct 3, 2012 12:28pm EDT

By Gerard Wynn

LONDON Oct 3 (Reuters) - The European Commission's ambition for a single energy market conflicts with aims in Britain and other countries to boost their own national energy security by paying investors to ensure gas-fired power capacity is available several years ahead.

The EU wants to achieve a single, liberalised energy market by 2014, to cut prices and carbon emissions while boosting security of supply.

Meanwhile, Britain plans to pay gas-fired power plants under a capacity mechanism that it is due to announce before the end of the year.

Such schemes work by allocating and paying for future power generating capacity, for example through competitive tenders, and as such are centralised, public efforts to plan future capacity rather than leave that entirely to energy market price signals.

The Commission, in a draft communication to member states and the European Parliament, says it prefers alternative approaches to ensuring security of supply, such as use of interconnectors to pool countries' power generating resources, and a greater role for efficiency.

Both are right: it is true that gas-fired power is the best back-up for renewable power and capacity payments are a good way to ensure it is built, but focusing on national security will distract from increasing cross-border transmission capacity.

The UK and Commission positions are not irreconcilable: both agree that capacity payments work better if they are available to energy efficiency projects as well as power plants, and Britain's impact assessment published last December appears to agree that they are a time-limited solution.

Britain will lose about a fifth of its generating capacity over the next decade as older and more polluting plants retire, prompting near-term anxiety about capacity and blackouts.

The European Commission draft says that it will conduct a consultation, "aimed at ensuring (capacity mechanism) interventions are as limited as possible in scope and time."

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Draft Commission memo on internal market:

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LIMITS

However, the European Union executive goes further, making clear it views capacity mechanisms sceptically and prefers alternative approaches.

Under its goal of creating a single EU energy market, the Commission wants to do away with price regulation and concentrated ownership of transmission and generation assets, and drive greater cross-border power and gas connections and trading.

It is concerned that national capacity mechanisms, where governments contract for national capacity years into the future, will interfere with such cross-border links.

Capacity markets already exist in Spain and certain U.S. states and have new impetus in Europe as a result of support for renewable energy, which is eroding peak power prices and so undermining market incentives for gas-fired power, vital as a back-up for intermittent wind and solar.

The Commission draft states that plans for capacity markets are likely to fall under the EU's single energy market directive and possibly state aid rules, a reminder which appears calculated to enforce new criteria for approval.

"In view of this, member states should not introduce capacity mechanisms before carrying out a full analysis of the existence and possible causes of a lack of investment in generation," says the draft, "Making the internal market work", dated Sept. 7.

"Moreover, member states should analyse the necessity and the impact of their planned intervention on neighbouring member states and on the internal energy market."

"They should examine alternative approaches such as peak-shaving measures, increased imports through appropriate interconnectors, and facilitating demand-side participation in the market of industrial as well as retail customers."

IMPACT

Britain may not welcome the draft communication.

It has already prepared an impact assessment which explains the investment case but makes no mention of impact on neighbouring countries.

The investment case follows from a growing role for intermittent renewable energy in supplying peak power demand, meaning that flexible gas-fired power plants must earn returns over shorter time periods, implying far higher power prices than historically when wind and solar power are unavailable.

The argument runs that investors may not trust governments to allow peak prices to rise so high, and so need an alternative incentive - provided through a capacity mechanism where they are paid a certain amount per megawatt of capacity simply to be available.

"A capacity mechanism reinforces signals from the energy-only market to ensure there will be sufficient flexible / despatchable capacity to meet peak demand," it says.

However, the British assessment makes no mention of the impact on neighbouring countries.

In addition, it confirms that low-carbon energy would probably be ineligible to compete for capacity payments, because renewable energy, nuclear power and carbon capture and storage would be guaranteed a minimum power price under a separate "contract for difference" scheme.

That appears to confirm European Commission concerns that capacity mechanisms will be a tool to support fossil fuels.

"Capacity mechanisms are likely to favour fossil fuel generation sources over more variable renewable sources and may therefore contradict decarbonisation objectives and go against the optimisation of available EU resources," the Commission draft says.

COSTLY

The Commission's arguments on decarbonisation appear illogical, given that a capacity mechanism is a policy tool precisely meant to deal with a rise in intermittent, low-carbon power.

And such schemes can cut carbon emissions further by creating a market in and thereby motivating non-generation technologies, for example allowing industrial companies to bid to reduce their power demand by a certain amount, or to lower their consumption at times of peak grid demand (demand side response, or DSR).

"A capacity mechanism helps to support the decarbonisation of the power sector by ensuring the a decarbonised power sector is still able to deliver security of electricity supply," says the UK assessment.

"Moreover if a mechanism helps enable greater DSR then it has potential to aid decarbonisation by reducing the need for peaking plants to be built and then only run in exceptional circumstances."

However, given the central purpose of a capacity mechanism is to ensure self sufficiency at a national level, it may directly undermine incentives to build out interconnectors, and the Commission is right that potentially it will raise costs and lead to greater energy price differences at an EU-level.

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