Assessing cross-border integration of capacity mechanisms in coupled electricity markets

Abstract

There is momentum in a number of European electricity markets towards the implementation of national generation capacity mechanisms. This renewed interest in capacity mechanisms raises the question of the cohabitation of both relatively well-integrated short-term energy markets and national generation capacity mechanisms. This paper examines a key issue of generation adequacy policies in a multi-market environment: the effect of foreign generators’ and interconnectors’ inclusion in national capacity mechanisms. The results show that the absence of cross-border participation could lead to significant social welfare losses associated with over and under-capacity procuring risk. This implies a vicious circle: as capacity mechanisms over or under-procure capacity, cross-border trade of electricity becomes more distorted, which in turn undermines the effectiveness of capacity mechanisms themselves. The findings also show that the inclusion of interconnectors in national capacity mechanisms could induce investments in merchant interconnections by compensating for network externalities and adjusting profit levels on the basis of the interconnection costs. However, despite the participation of interconnectors in capacity mechanisms, the exclusion of foreign generation of this market-based scheme undermines efficiency. In the absence of a wider EU single capacity mechanism, the inclusion of foreign generators and interconnectors in national capacity mechanisms should ensure the most efficient cohabitation of the EU Single Market and national capacity mechanisms.