In Germany – but not only there – there is a heated debate about the pros and cons of a capacity market. The German Renewable Energy Association is against it, and recently the German New Energy Industry Association, the DIHK and the EEX energy exchange have also taken a clear stance: Germany does not need a “power plant subsidy program.” In this article, four experts explain why battery storage can also play an important role in a capacity market and make recommendations on how the design of the market can help avoid mismanagement, wrong incentives and unnecessary costs.

Why a German capacity market?

With the German Kraftwerksstrategie, which also includes the agreement of a technology-independent capacity market, the German government is focusing on ensuring a fully renewable electricity system. The capacity market uses long-term contracts for available generation capacity (paid in €/kW) to ensure that there is sufficient energy available at every hour of the year to meet demand even in rare exceptional cases. One thing is certain: with increasing shares of renewable energies and the coal phase-out, controllable generators and storage systems are needed to keep production and consumption in balance. A recently published study by Frontier Economics shows that battery storage can reduce the need for gas-fired power plants in Germany by 9 GW, saving billions in construction and operating costs for 18 additional power plants and emissions of up to 6.2 million tons of CO2.

International experience in Belgium, the UK, Poland and Italy

Capacity markets have been successfully introduced in various European countries in recent years. After the UK took the lead in 2014, central capacity markets have been implemented in Belgium, Italy, Poland and Ireland. In Spain, a capacity market is currently in the legislative process. In the EU, the Agency for the Cooperation of Energy Regulators (ACER) sets the framework for the use of capacity mechanisms, while the final decision on this rests with the Member States and the European Commission.

The design of the capacity markets in the various European countries is therefore subject to a similar structure: in a central annual auction, a fixed amount of capacity is demanded by a central authority, similar to the transmission system operator in the UK and Poland. This capacity can be offered, for example, by power plants, storage facilities or through demand response.

The capacity markets in the UK and Belgium, for example, follow this central principle (see table). In contrast, the French model, in which the capacity in demand is procured in a decentralized manner and in which the individual energy suppliers are obliged to purchase capacity certificates from power plants and other electricity producers, has not yet been able to establish itself.

The annual auctions take place four years (T-4) or one year (T-1) in advance of the start of the respective contract term. The term of the capacity contracts ranges from one year for existing plants to 15 to 17 years for new plants. This is meant to provide the latter with the necessary investment security over the financing period of the project.

During the term of the contract, all plants receive a fixed remuneration per megawatt per year based on the auction result. In return, they must be available during this period and are subject to certain physical or financial requirements depending on the structure of the respective market. Emission limits stipulate that coal-fired power plants and other plants with high CO2 emissions cannot participate in the capacity markets. This can also create incentives for natural gas power plants to switch to hydrogen.

Key points of a successful German capacity market

In order to avoid risks of mismanagement, misincentives and unnecessary costs, a well-thought-out and efficient capacity market design is essential. This can, for example, avoid the risk of so-called windfall profits going to power plants that do not need support or of power plants being artificially kept alive that would otherwise be eliminated from the market.

Experience from the capacity markets already implemented in Europe shows that the capacity market design to be created for Germany must take the following key aspects into account to be successful: firstly, the derating factor, secondly, the handling of plant availability and refinancing, and thirdly, the local distribution of the participating plants. The contract terms and auction horizons as well as options for mapping plant degradation and, finally, the choice of auction format between “pay-as-bid” or “pay-as-cleared” are also important.

Derating factor

The derating factor enables the participation of different generation and flexibility options in the capacity market. It indicates what percentage of the nominal output of a particular technology is remunerated by the capacity market and thus serves, for example, to make the contribution of battery storage systems with different storage durations to system security comparable. Depending on the capacity and the selected operating mode, a storage system can provide a given output for different lengths of time (for example 2 hours, 4 hours, 8 hours).

Determining derating factors should be based on how likely it is that a particular technology will be available during the most critical bottleneck hours of a year or quarter. In “mature” or well-established capacity markets such as MISO (Midcontinent Independent System Operator) in the USA, 4-hour batteries have been shown to be as reliable as gas or coal-fired power plants during the 3 percent (262 of 8,760) most critical bottleneck hours of a year, and have a derating factor of over 90%. The reason for this is that of the 262 most critical bottleneck hours, hardly more than 4 hours were consecutive, giving batteries time to recharge. In addition, batteries are less prone to failure than thermal power plants and have an availability advantage.