Keynote speech of JM Glachant at the 9th Annual EU Energy Law & Policy Conference of Claeys & Casteels, on 11.02.2014 in Brussels

1. Recent developments in Capacity
Remuneration Mechanisms
-Dilemmas in the EU-
Jean-Michel Glachant
Director Florence School of Regulation
European University Institute (Florence, Italy)

2. The CRM dilemma in Europe
Two conflicting goals:
Security of supply of electricity in Europe is challenged by climate policy and RES
targets:
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Short-term flexibility required to cope with the variability introduced by
intermittent RES,
Long-term generation adequacy endangered by lower returns as a result of RES
penetration, and decommissioning of conventional units.
Will market signals be sufficient to ensure security of supply?
Two conflicting tools:
Capacity Remuneration Mechanisms are seen as a tool to ensure generation
adequacy
… BUT the impact of national schemes on the internal energy market is
not clear.
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 Are we solving a current dilemma: security of supply vs. climate objectives?
 Are we creating a new one: capacity remuneration mechanism vs. IEM ?
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3. The rationale for CRMs in Europe
CRM in theory (1): The "missing money"
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Some “back-up generators” are only needed a few hours a year, at times of scarcity (no
wind, no Sun, plant failures, high demand).
BUT at times of scarcity, the network (and the market) collapse.
There is no way for “back-up generators” to receive scarcity prices through the
market prices.
Some second-best tricks are used: prices are capped and reserves level are set
administratively.
BUT these prices are not high enough (political acceptability of high prices) and some
of the actions taken by system operators are unpriced.
Scarcity rent reduced for ALL generators (not only peak units).
And it is gets worse with intermittent RES as recovery (and pricing) at times of scarcity
matters more for thermal generators displaced by RES and therefore running less
often a year.
NB. “Missing money” does not last as investors need a return => “Missing capacity”
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4. The rationale for CRMs in Europe
CRM in theory (2): The “missing planning”
Market risks and the cost of capital (little merit)
= “Need to stabilize the revenues of generators and hedge against high volatility of prices
so as to lower risks and costs of capital.”
BUT prices volatility should NOT be an issue: oil refineries still get built.
BUT(2) risk does not disappear, it is transferred to consumers and taxpayers.
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Political uncertainties and long-term coordination (more merit)
“Will prices be allowed to rise ?” : Risks of ex-post market adjustments by policymakers
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“Who will provide a hedge against political risks ?” : e.g. no credible future markets for
carbon price, while subsidies are not durable.
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Current irrelevance of the spot energy market to coordinate investments as strong
policies drive the generation mix.
 If no credible market can be implemented, some form of long-term contracts are
needed.
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5. The rationale for CRMs in Europe: really ?
Solving the missing money issue: which definition?
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What is needed is not capacity (as ‘steel in the ground’), but the ability to generate
when and where needed.
Current trend in Europe is to implement a simple CRM associated to complementary
signals for short-term flexibility.
Can adequacy be conceived as separated from flexibility in a context of large-scale
development of intermittent RES ?
How to define the adequate capacity product(S): standards or penalties if not available
when needed ? What delay for availability ? Which cycling capability ? How many calls a
month ? Which locational signals ?
Definitions are not technology neutral!
Demand response has a huge potential to take part into capacity markets and can bring
huge savings, as seen in the US.
BUT design matters: it can respond very with very short-notice (Needed/Remunerated in
CRM?) but cannot be available for one week (Needed/Penalized in CRM?)
CRM timeframes (call 3/4 years before availability) often hardly compatible with the
development of transmission assets.
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6. The rationale for CRMs in Europe: really ?
Solving the missing planning issue: which implementation?
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Risks of seeing the government/TSO to become the consumer, with numerous
uncertainties to handle:
– International negotiations for climate policy, RES targets, energy efficiency
targets
– Market design: target model and cross-border infrastructures
– Technological game-changers: PV costs, Demand-side management
– General economic environment: demand growth, cost of capital
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Capacity markets are in any case heavily regulated and risks of miscalibrations are
high. Design does not only determine how much we need, but which resources we
need (New units? Clean Units? DSM? Transmission?)
Especially costly to commit too much capacity at times of: low demand
growth/technology shifts/shorter lead time to build new plants.

 Do we really want to go back to central planning at times of high uncertainty?
 Missing money can also result from overcapacity: important not to compensate
overinvestment.
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7. Individual CRMs and the IEM
Probably not one harmonized CRM
Already a patchwork of capacity mechanisms in Europe
Different needs and priorities lead to very different solutions.
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Roadmap Priorities
France
Germany
Netherlands
UK
1/Affordability
2/Security of supply
1/Industrial opportunities
2/Security of supply
1/Affordability
2/Industrial opportunities
1/GHG mitigation
2/Affordability
Challenges identified
Mechanism
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Increasing peak demand
Increasing share of RES
Capacity obligation on
suppliers
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“Missing money” due to RES
Closure of nuclear plants +
congestion in transmission network
“Transitory winter strategic
reserve” in the South
+ Ongoing discussions
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No perceived need
“Safety net” never used
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Closure of existing capacity
More intermittent & inflexible
generation
Centralised auction
Source: Climate and Energy Roadmaps towards 2050 in north-western Europe (PBL)
Capacity Mechanisms in Northwest Europe (CIEP)
 Unlikely that a common scheme can fit all.
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8. Individual CRMs and the IEM
Will a patchwork of CRM endanger the IEM?
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Barriers to trade
= “Does market coupling still make sense between neighboring countries with different
capacity remuneration mechanisms ?”
YES, prices can be kept consistent in theory… and in practice (UK-Ireland) by distinguishing
the energy remuneration from the contribution to generation adequacy
BUT there are obvious requirements, like opening these schemes to cross-border capacity.
 Not so trivial: how to measure the contribution to security of supply of a unit in an
other system?
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Investment distortions and capacity leakage
= “Any risk that states will compete for capacity by offering attractive remuneration
schemes ?”
 MAYBE, BUT not a problem if firm capacity is sold to the one who values it the most
(See energy market coupling: the one who pays the most gets it all)
 Emergence of a “coupled capacity market” will increase cost-efficiency.
In coupled markets, there cannot be a pure national scheme for capacity remuneration, as
energy prices are impacted by the situation in neighbouring countries. There will only be
hybrid models based on: national capacity revenues + coupled energy prices.
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9. Individual CRM and the IEM
There are many other sources of distortions
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Reliability constraints are different in each member states:
– Different targets are in place:
E.g. max 3 hours/year of shortage in France vs. 10% capacity margin in Spain
– Different methodologies are employed to calculate contributions of a given unit to
the system reliability (cross-border capacity, intermittent RES)
– Different practices exist to ensure security (Imbalance penalties for instance)
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Intermittent RES accounted for 70% of new installations in 2012, driven by renewable
support schemes that differ (A LOT) in each country !
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There are still very different market arrangements: mandatory pool with low price caps
and additional payments(Italy, Spain) vs. exchanges with high price caps (CWE,
Nordpool).
Many
other sources of distortion exist in the EU, without preventing the implementation
of market coupling.
Common reliability methodology is more important than harmonised CRMs to ensure
that a coupled capacity market can emerge.
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10. Conclusion
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The story is the following:
1/ No reason why a pure energy-market should not deliver the right signals and hedging
possibility against price volatility, even in a fast evolving-environment
2/ BUT there are many interventions currently preventing the market from functioning
properly
3/ SO a patch is needed: here come the capacity remuneration mechanisms.
European Commission focusing on solving 2/
[Guidelines on RES support; Towards a single greenhouse gas emission reduction target?]
BUT
Member States already moving towards 3/
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The real issue: Will 3/ prevent 2/ ? Can 2/ be solved after a temporary 3/ ?
- The market can work with different national schemes. The main issue is not national
capacity mechanisms, it is the way reliability is conceived in a national way.
- It is difficult to establish common reliability standards BUT there is a need for a
common methodology to assess reliability.
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11. Thank you for your attention
Email contact: jean-michel.glachant@eui.eu
Follow me on Twitter: @JMGlachant
Read the Journal I am chief-editor of: EEEP
“Economics of Energy & Environmental Policy”
My web site: http://www.florence-school.eu
www.florence-school.eu
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