The other Electricity Cash Cow, the Capacity Mechanism

The capacity mechanism is a cornerstone of the French national energy independence. With the deployment of renewable generation and the decision to phase out coal and fuel-oil generation, matched with ageing nuclear powerplants, the need made itself felt in the early 2010’s to ensure enough capacity was available during peak hours to avoid system failures. In particular, there were some capacities which were not profitable overall because they could produce at a margin only a few hours a year. Therefore, the rationale of the mechanism was to help keep these capacities in the market and encourage the development of new ones. After a request made to the European Commission, which was contrary to interference in the energy market, to accept the new mechanism, France opted for a decentralized capacity mechanism, in theory more coherent with free market principles, whose objective was and is to guarantee the long-term security of electricity supply in France. Entering into force in January 2017, the current mechanism is set to expire in 2026, after a decade of operation. Important high-level discussions are underway for the development of a new mechanism, which could continue being a major source of revenue for many actors for decades to come.

The current French capacity mechanism is based on a singular arrangement, universal and decentralised. Universal because any contributor to system reliability, producer, or demand side provider, receives the same payment with no discrimination by type or technology depending on its actual contribution to system reliability. Decentralised because the exchange of capacity occurs between contributors and demanders (customers). Each electricity producer (or demand side flexibility provider) must certify their production capacity at the height of their expected availability during peak hours.

EdF image showing how during peak hours, even with all technologies employed (right) there might not always be enough power available

Meanwhile, each supplier is required to obtain capacity guarantees to cover the consumption of all its customers during periods of peak national consumption. Producers can sell their guarantees to suppliers or traders, bilaterally or through organized auctions. The contribution and obligation of actors are measured on days designated as peak days by the TSO, during peak hours: from 7 a.m. to 3 p.m. and from 6 p.m. to 8 p.m., i.e. 10 hours. Peak days are of two types, PP1 and PP2. PP1 days apply for consumers, while PP2 days apply for producers. There are a maximum of 15 days PP1 and 25 days PP2 per year.

RTE image showing producers (green) and suppliers (orange) exchanging capacity contracts for a given year.

Although the capacity mechanism was successful in bringing a significant new source of revenue to actors (especially electricity producers), and consequently ensuring the French system stability during peak days, several actors now perceive that the system has several drawbacks: complexity; price volatility; main actor’s role; and lack of foreseeability.

Even several years onwards, most of major market players have a limited understanding of the intricacies of the system and tend to have a sub-optimal participation to the capacity certificate’s market. Moreover, some large market players, in particular national energy company EdF, have a preponderant effect both on the supply and demand side during auctions. Coupled with the fact that actors, unlike what was idealised, do not certify 4 years in advance but often do so at the last minute, this overall situation leads to huge changes in supply and demand from one auction to another. In turn this entails two issues: a difficulty in foreseeing the true availability of production and flexibility capacities for a given year, leading to increased system risk, and a significant price volatility introducing a financial risk for producers, suppliers and consumers. For example, the last auction of 2022 for contract 2023 settled at a price of 60k€/MW, meanwhile the same auction a year later, for the contract 2024, settled at 6.2k€/MW, almost 10 times less.

HES graphic showing auctions’ results for different delivery years

Entering into force in January 2017, the current mechanism is set to expire in 2026, which means that important high-level discussions are underway for its renewal and improvement. The first question on the table is whether France will need a capacity mechanism after 2026. Producers benefiting from the mechanism would like the mechanism to keep on in any case. Suppliers, while theoretically exerting a contrary force, desiring to keep electricity prices low, in fact tend to pass through the capacity price to consumers. Therefore, there is a formidable force in favour of renewing the mechanism independently of whether it will be necessary.

The other major question is whether the EU will allow France to adopt a new capacity mechanism. Although in its green transition the French electricity system will keep on benefiting from a huge modulable power source, nuclear, while other countries leverage much more on weather-random wind and solar. It is nonetheless true that renewable sources will play a key role in France as well. In this new European context, with high intermittent renewable power generation, the EU considers national capacity mechanisms a useful device to ensure system security, unlike before when they were considered a barrier to a free market. For sure, any capacity payment decided by any member state must be checked by the EU authorities to make sure that it is not disguised as state aid.

What will the future French capacity mechanism look like?

The new system aims to tackle several of the weaknesses of the current one. Joining UK and Italy, as shows from high-level discussions coordinated by the national grid operator RTE, the system is directing itself towards a centralised capacity mechanism, with RTE as the main counterparty. There will be fewer auctions than now and strict obligations to certify in advance. This will allow a significant simplification for all participants and increase the foreseeability of capacity available 4 years in advance. Moreover, the main auction being held 4 years in advance, this ensures that actors will have a clear price signal. Of course, the natural counter-effect, with a beneficial decrease in financial risk, would be that market participants will have less ability to adjust their positions and to maximise economic benefits.

The current developments increase the importance of closely monitoring the regulatory process, as one of the main sources of revenue for capacity and flexibility providers for the coming decades is under formulation. For some energy actors, the capacity mechanism represents a sizeable fraction of their yearly revenues, especially when they do not operate all year round but mainly during high price periods.

From the customer’s side, the cost of the new capacity mechanism will be like other network charges. No more management or hedges on prices will be possible under the new mechanism. However, strategic decisions can be taken because peak shedding and shifting will still be valuable as cost withdrawers.

As the new mechanism is still under discussion, we recommend producers and suppliers to participate as much as possible while some debate is open, to maximise profits and contribute to regulatory developments. You can count on HES both thanks to its consolidated experience with the French capacity mechanism and its continuous monitoring of European markets and regulation.

Enea Albertoli

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Each month, one of our experts publishes an article describing his view on a specific topic of the constant changes taking place in the energy market, with special focus on the French market.

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Céline, a young and dynamic person, had a first experience in the tourism sector as a community manager at Loups du Gévaudan, in Lozère. She joined HES team in November 2021 to diversify her knowledge: learning about the energy sector, specialising in marketing strategies in order to improve the company’s customer relations and, at the same time, developing her skills in coordination and project management.

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Céline graduated in Spanish and English Language, Literature and Civilisation at La Sorbonne IV (2018). She also holds a master’s degree II in cultural projects and establishments management, with a special focus on international tourism. She also studied abroad at the University of London (England) and Universidad de Morón (Argentina).

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Marketing Responsible

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Investment Advice

“Decarbonization of the Energy and Transport sectors is arguably today’s main economic driver for the industry.”

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His career started in civil engineering as a Project Manager in France, Martinique and Australia. Afterwards, he became the General Manager of a subsidiary in Venezuela. In 1992, he established Dalkia in Germany (district heating, cogeneration, and partnerships) and represented Véolia in Thailand. In 2000, he opened the commercial office of Endesa in France to take advantage of the liberalized retail market. From 2006, as a development Manager at Endesa France, he led Endesa’s plan for Combined Cycle generation in France and developed the wind and PV portfolio of Snet at the same time. Philippe Boulanger worked for 3 years at E.ON’s headquarters coordinating the company´s activities in France. He was strongly involved in the French hydro concession renewal project. As a Senior Vice President – Project Director at Solvay Energy Services from April 2012 to February 2014 he was in charge of the H2/Power to gas and European direct market access deployment projects. Philippe has been an HES expert since 2014.

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Philippe Boulanger holds engineering degrees both from the Ecole Polytechnique and the Ecole Nationale des Ponts & Chaussées (France) and has a combined experience of more than 25 years in energy and infrastructure. In addition to English, Mr. Boulanger is fluent in French, German & Spanish.

Philippe Boulanger

Electricity Expert

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“The world is changing. New investors pay particular attention to the energy sector while historical actors adapt their position to the market.”

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Antonio started his career in the electricity sector in 1991 working as a member of staff for the General Manager of Sevillana de Electricidad (Spain). In 1997, he was in charge of the commercial regulation at Endesa Distribution. In 2000, he joined Endesa’s European M&A department. He was appointed CEO of Endesa Power Trading Ltd in 2003. He became Head of Energy Management for SNET, France, in 2004 and was appointed CEO of this company in 2008. In 2009, he held the position of Head of Corporate Development for E.ON France. In 2011, he founded Haya Energy Solutions (HES), a consulting firm which assists companies in optimizing their value chain: from strategy definition to day-to-day operations, based on a strong experience and understanding of the energy industry. From 2015 to 2018, Antonio was Chairman and CEO of 2 French CCGTs (2x410MW), owned by KKR. At the end of 2018, he joined Asterion Industrial Partners, a dedicated infrastructure investment fund, as an Operating Partner.

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Antonio graduated from the Escuela Técnica Superior de Ingenieros of Seville (Spain) and holds an MBA degree from Deusto University (Spain).

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