Wednesday, May 12, 2021, the deadline for submitting allegations to the Draft Order that creates a capacity market in the Spanish electricity system is over. A long-awaited regulation by agents of the electrical system since the penetration of variable renewable energy, such as photovoltaic and wind, is continuously growing and will continue to do so. It should be remembered that Order TED / 1161/2020 establishes the indicative calendar for the 2020-2025 period and foresees a volume of renewable power of 19,540 MW for the year 2025, which represents approximately 18% of the total generation park current in Spain.
A penetration of renewables in the generation mix that causes whirlwinds in spot prices, such as those seen in the last week, and generates many questions about the structure of the current electricity market. Questions such as: Will it be able to guarantee the economic viability of these technologies? What about the flexibility and firmness (power that an installation will be able to offer in times of peak demand) needs of the system – which must be increased? The high penetration of renewable energy casts doubts on the effectiveness of energy-only markets to give signals for the necessary investment in firm power, and in flexibility.
In a marginal price matching system, with presence of renewables that have a downward effect on prices (there is even talk of a cannibal effect) and that are not manageable, the different technologies that show firmness (dispatchable or programmable energy sources) would recover their fixed costs when those renewables do not produce. Today, even those facilities that do turn out to participate in the market are showing significant difficulties in ensuring positive cash flows. Hence the need to establish a mechanism that provokes the necessary long-term investment, a capacity mechanism that guarantees not only firm power or reserve margin, but all those system reliability services that the market is not capable of providing energy-only.
In this blog we want to expose the keys to this new capacity market proposed by the Ministry for the Ecological Transition and the Demographic Challenge in Spain that seeks to answer the questions generated.
THE EXISTING CAPACITY MECHANISMS
Mainly five models of capacity mechanisms can be distinguished. At both ends of the scheme presented, there are the so-called strategic reserves and the capacity payments:
The main feature of the first one is that those facilities that are set up as a strategic reserve cannot participate in organized markets, which is an important limitation for those assets that choose to provide this firmness service (Germany model).
Payments for capacity, meanwhile, correspond to a model equivalent to the one currently existing in Spain. This service does not incorporate the necessary characteristics of competitive competition to ensure its compliance with European community principles, nor does it respond to a coverage analysis that identifies firm capacity needs in the Spanish electricity system. The problem is how to determine the correct price, and then how to evolve it as technology changes. In addition, another problem is that it is usually overestimated because if it is too low there will be no investment, which translates into higher cost for consumers. It seems that there are many more advantages to a system in which the price is revealed by the market.
The market models that promote long investment through a centralized or decentralized volume signal, would be:
- The capacity obligation which is constituted as a decentralized model in which electric power marketers are required to acquire certain firmness obligations in a decentralized market in which the product offered (firmness) is offered by generation, the demand and storage (France model).
- The so-called reliability options which constitute a more sophisticated mechanism that, in short, involves the definition of price strike, or reference price, which serves as a signal price for capacity service providers. It is very difficult to stablish the value of such reference price.
- The capacity market corresponds to a centralized capacity mechanism model, assigning this responsibility to the system operator (OS). The OS can call a capacity auction to ensure the presence of this power at critical moments in the system. And this capacity can be supplied by both generation and demand. The idea is that this auction would be won by the technology with lower investment costs, in the case of requiring additional power, or by the technology with lower fixed O&M costs, in the case of power already installed, always considering its capacity to recover at least its variable cost, or even a part of its fixed cost, in the market.
In both cases, the important thing is the correct design of the reliability products, and the way to acquire them. A design that must consider not only the need for firm power, but also the need for system flexibility. In this sense, what should be sought is to prioritize the capacity of the technology to be present in the truly critical moments of the system, practically unexpected moments, to really solve the problem of guarantee of supply.
THE CAPACITY MARKET BET
The centralized capacity market as a backup for renewables is the government’s bet. The new market will be constituted as a centralized system in which the system operator, Red Eléctrica de España, will contract the required firm power, that is, the power offer by an installation in times of peak demand, depending on the needs that detect in your analysis of demand coverage.
This firm power must ensure its availability at times of greatest stress for the peninsular electricity system and will be contracted through competitive bidding procedures managed by the system operator through “pay-as-bid” auctions: the promoters bid on the price that they are willing to charge for the availability of their firm power capacity, which is the price assigned to them if their project is awarded.
The participants in these auctions may be demand aggregators, generation, or storage facilities, including self-consumption facilities, provided they meet the established requirements. The inclusion of storage is key to reinforcing compliance with the objectives of the Energy Storage Strategy, approved by the Government last February, which contemplates having a total capacity of about 20 GW in the year 2030, with 8,3 GW of storage available today.
The regulation provides for two types of capacity auctions:
- Main auctions with a service provision period of 1 or 5 years, depending on whether they are existing facilities or new facilities.
- Adjustment auctions with a service provision period of 12 months. The purpose of these last auctions is to resolve eventual coverage problems that will not be covered by the firm power of the principal.
The policy will provide clear and transparent price signals in the long term, which creates predictability and encourages investment. This will facilitate that clean technologies that are currently less mature, such as energy storage systems, can enter the generation mix as they become more competitive, which will allow them to displace more polluting technologies and will increase the share of electricity generation from clean sources.
Finally, the ultimate objective of the rule is to prevent the price from spiking at peak times, as happened last January, with Filomena weather phenomena. Capacity markets, compared to market designs based exclusively on energy-only, help to avoid episodes of very high prices in times of scarcity, reducing price volatility and giving certainty to consumers, producers, and holders of storage facilities.
AUCTIONS SPECIAL FEATURES
The auctions will be called by resolution from the Secretary of State for Energy. The owners of the facilities that are awarded will constitute themselves as suppliers of the capacity service, having to comply with what is established in the order and with the operating procedures that develop it.
This capacity market must comply with the general principles apply to the capacity mechanisms established by community regulations (Regulation (EU) 2019/943 of the European Parliament and of the Council of June 5, 2019 on the internal electricity market). Among which the principle of technological neutrality stands out, which allows both generation, storage, and demand to participate in auctions if they meet the established requirements.
Due to the diversity of technologies and their different ease of safely offering a megawatt of power at times of peak demand, the standard creates firmness ratios, which establish an equivalence between different forms of generation -with and without storage- to evaluate the ability of each technology to be available at times of greatest power shortage. The firmness ratios will consider the intrinsic and extrinsic elements of each technology, considering the coverage and flexibility needs of the peninsular electricity system and incorporating the capacity of each technology to satisfy them.
Also, the policy is constituted as a temporary instrument whose mechanism will be reviewed at least every ten years, it will not create unnecessary distortions in the market and will establish incentives to ensure the availability of these technologies when they are necessary, thus complying with the general principles of application. In fact, during the validity of the implemented model, an analysis will be carried out in such a way that, if the experience and the studies collected conclude that there is no need for the backup mechanisms, it must be terminated.
Likewise, the order sets a maximum CO2 emission limit of 550 grams per kWh for existing generation facilities participating in the mechanism, in line with community regulations. Combined cycle plants will then be able to participate. For their part, new investments that wish to participate in the mechanism must prove that they correspond to non-emitting facilities (0 grCO2 / kWh).
The draft order also regulates the remuneration regime for service providers, which is configured as a fixed monthly remuneration in € / MW based on the firm power assigned and the price resulting from the matching in the capacity auctions held. In addition, it includes a scheme of penalties in case of non-compliance by the subjects in article 25.
According to the policy, the capacity market will be financed, as up to now, by all electricity consumers and will be established as an energy term (variable part of the bill) by tariff segment and hourly period, analogous to the structure established for transport and distribution tolls and charges that will come into effect on June 1, depending on firm power needs.
The draft Order creating a capacity market in the Spanish electricity system is already being well received in the sector, pending receipt of the report to the National Markets and Competition Commission.