The first auctions on the capacity market - this is how it went

The experts call it the “Capacity Market”.

The mission of the capacity market, which has already begun, is to serve as a buffer zone for the Italian electricity system that can provide oxygen and muscles to meet the big transition challenge. A cleaner electricity system thanks to the growing recourse to renewable power generation. It is safer thanks to the modernisation of the grid with new intelligent technologies, and it is cheaper thanks to progress in operating efficiency. But are there any problems to face? Quite a few.

Growth in renewables, which are making headway thanks to increasingly competitive costs, must address the issue of programmability that is not always guaranteed. The conventional and programmable generation plants continue to be indispensable to supply the right amount of energy our country needs at all times. In a scenario going from the generation abundance of the years from the end of the second to the beginning of the third millennium to bearing the brunt of plant decommissioning of the last ten years the reserve margin has been drastically reduced.

The system demands sustainability, transition to low carbon technologies, safety and economy. Not an easy operation. The Capacity Market holds the key to solve this equation. In the not too distant future, we will have a marked prevalence of renewables, with hydroelectric or electrochemical (batteries) storage systems that will solve the problems associated with the intermittent nature of production and high demand fluctuation.

A transition tool is therefore needed today that can guarantee a buffer zone for the system. A tool that can first of all make the definitive phasing out of coal practicable, but also a tool that can stabilize energy costs and price dynamics, giving operators a reliable framework to deploy their investment strategies and to strike a good balance for the country between security of supply and energy supply costs, with the clear objective of pursuing the fastest possible decarbonization process.

The goal of the mechanism is to accompany the transition phase towards renewable sources of energy allowing the decommissioning of the most inefficient and polluting plants, that would otherwise be necessary to guarantee meeting the demand for energy, through a programmed introduction, or the continued operation of relatively more efficient, more flexible and less polluting generation capacity.

Even gas thermoelectric plants, the most efficient type of plants to date which are prevalent in the Italian energy production mix, will be destined to carry out a completely different role, to be used for much less time as a backup system for renewable sources when there is greater demand on the grid.

A balancing act. The Capacity Market is based on two fundamental criteria: a premium for the capacity of power generation or power storage plants that is determined in a competitive way, providing minimal profitability - which otherwise would not always be guaranteed - in order to enable the implementation of those investments that are necessary to achieve the phasing out of coal plants in the context of overall Energy Security; and the obligation for operators to make available their allocated capacity to ensure that electricity demand is met at all times at a reasonable price for consumers, the so-called strike price, which is set to cover the higher cost of production in Italian power generation facilities, limiting any extra profit at the same time.

A choice has therefore been made for an auction mechanism, open to all those existing plants, and plants to be built for such purpose, that can guarantee results that in any case reflect the minimum requirements of efficiency and emission control.

Auctions under the new capacity market, which supersedes and replaces the temporary capacity payment system which was implemented in recent years by distributing incentives in a regulated manner to a series of plants on the basis of their availability in times of need, were inaugurated by Terna with two sessions last November, thereby guaranteeing the first operational effect on our electricity system between 2022 and 2023. The basic scheme continues to be that of guaranteeing minimum profitability for plants that are requested to ensure the safety and continuity in the supply of electricity, on the basis of a premium resulting from the outcome of these auctions with the obligation for producers to return any price differential on the energy and dispatching market with respect to the strike price, which is linked with the variable cost of production of peaker plants.

At the end of this article there are links to the detailed reports on quantities at play, outcomes and assignees. But let us first try to get a better understanding of how things went and what the expected benefits are.

A great start. Two positive elements were highlighted by the start of the operation: the huge participation, both in numbers and in the type of operators (there are the big names like Enel, Eni, Edison and Sorgenia, - but there are also the main municipal companies, starting with A2A and Iren - and industrial enterprises such as Duferco and Arvedi) and in their geographical distribution, which however, favoured the North as a consequence of its greater needs; and a participation of the renewables which refused other forms of incentive and electrochemical storage (the latter had a capacity of more than 200 MW).

Evidently, the participation of new capacity generation has favoured deliveries in 2023 compared to 2022 which presupposes a shorter time to build the infrastructures and obtain the relative authorisations. For 2022, 1.8 GW of availability will be added at peak compared to new generation for 2.8 GW, while by 2023 the capacity available at peak (probability) will be 4 GW. In total between 2022 and 2023 there will therefore be a new capacity available at peak for 5.8 GW which will correspond to a new installed capacity for 7.5 GW, part of which replacing existing plants.

The results were in line with expectations. The vast majority of operators have contributed a large part of their existing resources and promoted new initiatives that will be fundamental to enable the phasing out of coal plants and to respond to the needs of the system, even in periods of major tension on the energy markets such as those recorded on several occasions in recent years (as in the case of unavailability of French nuclear plants or peaks in demand linked to extreme temperatures or reduced hydroelectric production, which can reduce the availability of hydroelectric resources).

The expected benefits. The positive effects will begin to be seen from 2022, the year of the first contractual effectiveness of the mechanism, in particular regarding price signals, due to the monitoring that will be induced by the options mechanism. The conclusion of contracts in the capacity market will indeed hold producers back from offering resources on the energy and energy dispatching services market at prices above a certain level (strike price). Positive effects will also be determined by the increased competition that may emerge in the energy and services markets due to the availability of more resources, with the presence of new, more efficient, less polluting plants and lower production costs.

And in the give and take game who really stands to win? Everybody does. The consumer wins because there will be significant benefits on electricity bills due to a “cooling” of prices on the energy market as a consequence of greater efficiency including economic-financial efficiency of the generation system compared to a scenario where the Capacity Market had not been implemented. And the country wins in terms of environmental sustainability because it will finally be able to say farewell to coal-fired energy generation, long before many of our European neighbours, and significantly increase the renewables quota of the production mix. Even the production system wins as a consequence of the lower risk premium on the market.

Upcoming events. The launch of the new auctions cannot be instantaneous. It will be discussed in early 2021. Indeed, the institutional mechanism must act in accordance with complex procedures: the plans must be developed on the basis of an updated report on the adequacy of the system (that Terna updates annually in any case) and forwarded to the European Union which must analyse it and approve it. These procedures established very tight operating times for the auctions that have just taken place, if we consider that the definitive authorisations arrived late, at the beginning of last summer, and the auctions had to take place before December in order to avoid the expiry of the terms of the EU rules as provided in the Clean Energy Package (CEP).

The old mechanisms. As already mentioned, "capacity payment" will disappear starting from 2022, as indeed decreed by the relevant authority. Among the other accessory and supporting instruments of the electricity system, the interruptibility mechanism remains unchanged. This remunerates the amenability of some industrial consumers to have their energy supply instantaneously interrupted in the event of sudden and unforeseeable requirements of the system. Interruptibility - the engineers underline - is a different instrument compared to those for the adequacy of a different service, that envisages the activation of procedures within 200 milliseconds in the event of necessity due to instantaneous loss of interconnections or of significant elements of the grid or of power generation.