Capacity Markets

Capacity markets serve as a strategic mechanism to ensure that there is always enough electricity supply to meet peak demand.

What are Capacity Markets?

Capacity markets are structured marketplaces where assets are contracted and paid for their commitment to provide electricity or reduce demand during periods of peak usage or high volatility. Unlike energy markets, which focus on the immediate buying and selling of electricity, capacity markets are concerned with ensuring future availability. They operate on the principle that the system should be ready to meet demand spikes, even if those spikes do not occur frequently. This is critical for preventing grid instability, which can lead to power outages.

In these markets, asset owners and intermediaries participate in auctions where they offer their capacity—essentially a promise to be ready to generate or reduce power if needed. Market operators then accept bids based on the need to ensure that the grid can handle volatility and peak loads. Successful bidders receive payments for maintaining this capacity, whether or not it is actually called upon to generate electricity.

How Capacity Markets Work

Capacity markets are designed to ensure that there is always enough electricity available to meet peak demand and enough flexibility to deal with high volatility. This process begins with forecasting future electricity needs, particularly during peak periods. Grid operators analyze various factors, such as historical consumption data, weather patterns, and economic indicators, to estimate potential peak demand. Based on these projections, they determine the amount of capacity required to maintain grid stability, accounting for unexpected situations like severe weather or generator outages.

To meet these capacity requirements, grid operators conduct auctions where asset owners and intermediaries—ranging from power plants to demand-response providers—bid their capacity. The amount of these bids can vary significantly based on the age and type of the power plant. Older plants, having already covered their capital investments, often have lower operating costs, primarily consisting of fuel and labor, allowing them to bid lower. In contrast, newer plants face higher costs because their bids include both capital and operational expenses.

For instance, an older nuclear plant with minimal remaining capital costs might submit a very low bid, while a wind turbine, despite having no fuel costs, might place a higher bid due to its capital recovery needs. After gathering all the bids, the market operator sets the "clearing price," which is determined by the most expensive unit needed to meet the required capacity (e.g. 450 €/MW in the graph below). All resources that successfully bid into the auction receive compensation at this clearing price, regardless of their original bid.

This auction mechanism is critical in determining the competitive dynamics within capacity markets. The presence of more cost-effective resources can lower the overall market prices by displacing more expensive options, encouraging efficiency and cost-effective energy production.

The Impact of Capacity Markets on the Energy Sector

Capacity markets have a profound impact on the energy sector by providing a reliable mechanism to ensure grid stability and encourage investments in energy infrastructure. By offering predictable revenue streams through these auctions, capacity markets incentivize power producers to maintain and expand their operations, which is especially critical as the energy mix evolves with more renewable sources like wind and solar.

These markets also play a key role in facilitating the transition to cleaner energy. As older, less efficient power plants retire, capacity markets create opportunities for newer, greener technologies to compete. The auction system not only ensures that there is always enough power to meet peak demand but also promotes innovation and investment in sustainable energy solutions, making the grid more resilient and adaptable to future challenges.

Capacity Markets vs GOPACS

While capacity markets focus on securing long-term commitments to ensure the grid can meet peak loads, GOPACS (Grid Operators Platform for Congestion Solutions) addresses the immediate operational challenge of managing grid congestion. GOPACS, developed by Etpa, allows grid operators to collaborate with energy producers and consumers in real-time to alleviate stress on specific parts of the grid. This platform helps manage sudden surges in demand or localized bottlenecks, ensuring smooth grid operations. In contrast, capacity markets are more concerned with ensuring that sufficient generation capacity is available for future peak demand, providing a strategic reserve of power to prevent blackouts and ensure long-term grid reliability.

Conclusion

Capacity markets are integral to maintaining the stability and reliability of modern electricity grids. By providing financial incentives for energy suppliers to commit to future capacity, these markets encourage investment in both traditional and renewable energy sources. The auction mechanism, where the clearing price determines compensation, ensures that even the most cost-effective resources are rewarded, promoting efficiency and innovation across the sector. While capacity markets focus on long-term supply, platforms like GOPACS complement them by addressing immediate operational challenges, together ensuring that the grid remains robust and adaptable in a rapidly changing energy landscape.

Glossary

• Capacity Markets: Marketplaces where energy suppliers are compensated for committing to provide electricity or reduce demand during peak periods in the future.
• Clearing Price: The price set by the most expensive resource needed to meet the demand in a capacity auction, which determines the payment rate for all participating resources.
• Grid Stability: The ability of the electricity grid to maintain a balance between supply and demand, preventing power outages.
• Demand Response: Programs that incentivize consumers to reduce their electricity use during peak demand periods.
• GOPACS (Grid Operators Platform for Congestion Solutions): A real-time platform for managing grid congestion by coordinating adjustments in power usage or production.
• Peak Demand: The highest level of electricity demand observed over a specific period.