The idea of implementing a German capacity market has been floating around in Germany for more than a decade now and has been the subject of several consultation processes. The current administration has taken up the topic again under its Climate-Neutral Electricity System Platform, through which it has consulted broadly with market stakeholders. In August, the Federal Ministry for Economic Affairs and Climate Change (BMWK) presented its proposals following this process, including a proposed design for a national capacity market. The government is also developing a parallel ‘power plant strategy’, intended to cover the period before a capacity mechanism is implemented. This stop-gap measure is deemed necessary to secure the system while allowing for an accelerated phase-out of coal.
The power plant strategy divides power plants into two ‘pillars’—a decarbonisation pillar and security of supply pillar—depending on the policy objective that they are intended to support.
Under the decarbonisation pillar, the Government proposes to support the construction of 5 GW of new hydrogen-ready generation capacity and the conversion of 2 GW of existing gas-fired power plants to support the possible use of hydrogen. These power plants would be excluded from the capacity mechanism.
Under the security of supply pillar, the government proposes to procure 5 GW of new gas-fired capacity. These plants would participate in an eventual capacity mechanism. At present, Germany’s annual peak load is around 80 GW and its secure generation capacity is just under 90 GW. However, this secure capacity is projected to fall to just 66 GW by 2030, prompting the need for short-term measures to incentivise new build.
The capacity procured through the security pillar is not expected to contribute to Germany’s decarbonisation targets and the funding provided will be limited to covering the necessary CAPEX (investment costs). There are no explicit requirements for these plants to be hydrogen-ready and the process to secure state aid compliance approvals from the EU is nearly complete.
Turning to the enduring capacity mechanism, the government has put forward four options: hedging obligations, a centralised capacity market, a decentralised capacity market and a combined capacity market. It favours combining the centralised and decentralised approaches, creating what it calls a ‘Combined Capacity Market’, in its option paper ‘An Electricity Market of the Future’.
The centralised component would comprise centrally organised procurement rounds for capacity. These would provide payouts for extended periods, potentially up to the economic lifetime of the plant. This part of the design is intended to trigger capital-intensive investments with potentially long financing periods.
The decentralised component would obligate balancing group managers to cover their peak load capacity with traded capacity certificates. These managers could either contract for the necessary capacity, self-supply or reduce their obligations through peak load management. This part of the design is aimed at supporting more innovative, smaller scale and decentralised approaches (notably peak load management) that might be hard to incorporate into the central component.
Implementing this combined approach is expected to be complicated and would be the first of its kind. As such, it may result in protracted negotiations with the EU. Most of the details, including the intended design of the centralised procurement process and the penalties facing balancing group managers are still uncertain.
One of the most critical unanswered questions is how the centralised and decentralised components will interact in practice and what this might imply for the price of capacity in these parallel markets. The decentralised market is likely to be significantly dependent on the volumes of capacity procured centrally. There is therefore a risk that the decentralised market becomes driven by volatile policy-linked prices that do little more than shadow existing incentives like the energy and imbalance price. However, it might also provide a useful framework to secure capacity through from distributed and less capital-intensive measures, measures that might otherwise be overlooked.
We will be helping our clients to consider the implications of these proposals and their ongoing development, and drawing on the new ideas and lessons learned as part of our work on power market design.
