Capacity Mechanisms in EU Electricity Markets: Why Do Member States Implement Them? Analysis on German and Belgian Strategic Reserves

(1)

CAPACITY MECHANISMS IN

EU ELECTRICITY MARKETS

WHY

DO

THE

MEMBER

STATES

IMPLEMENT

THEM?

ANALYSIS

ON

GERMAN

AND

BELGIAN

STRATEGIC

RESERVES

Name: Student number: Master’s degree Date: Supervisor: Second reader: Word count: Ivan Helin S1541129

Crisis and Security Management, Leiden University 12 January 2020

Dr. Lydie Cabane Dr. Jeroen Wolbers 15,880

(2)

1. I

NTRODUCTION

1.1 R

ISE OF

C

APACITY

M

ECHANISMS IN

E

UROPEAN

U

NION

In recent decades, critical infrastructures have increasingly been privatized as market reforms have been introduced in many EU member states (Dunn-Cavelty and Suter, 2009). Electricity markets have not been an exception to this development, and today electricity markets across Europe are primarily in private hands (van der Burg and Whitley, 2016). This in turn creates an issue for nation states – which have traditionally been the main providers of security – as the functioning of their societies depends on these critical infrastructures such as electricity and water distribution, and yet they are no longer the in charge of the provision of security in these domains. In the case of European electricity networks, privatization has not been the only issue in relation to the security of supply as new developments such as the widespread introduction of intermittent forms of electricity generation such as wind and solar have created another worry for policymakers concerned about generation adequacy and possibilities of blackouts during peak demand (EPRS, 2017). Moreover, as these networks are increasingly complex and interconnected with electricity networks of other member states, the risks of potential blackouts are high as these could have an impact beyond national boundaries (Boin, Rhinard and Ekengren, 2014).

As a consequence of the worries over security of supply, several member states have decided to introduce capacity mechanisms, backup generations capacities which will be deployed in case electricity demand surpasses the usual electricity generation capacity (EPRS, 2017). Despite the intended objectives of these capacity mechanisms, several questions have arisen over their utilization in practice. EU Commission report from 2016 found that many member states have deployed capacity mechanisms without having made “an adequate assessment of the need for the capacity mechanism and that cost benefit assessments and evaluation of capacity mechanisms are the exception rather than a rule.” (EPRS, 2017, p.5). As a solution, the Commission has suggested that deployment of capacity mechanisms should meet strict criteria in relation to fixing an actual adequacy issue over electricity generation and be assessed properly (EPRS, 2017). Moreover, the Commission has suggested that capacity mechanisms “should be open to capacity providers in neighboring Member States in order to incentivize investment in domestic and foreign capacity and in interconnection, as well as to reduce system costs.” (EPRS, 2017, p. 5). Accordingly, ENTSO-E, the European Network of Transmission System Operators which coordinates the transmission system operators (TSOs) in Europe, states that there is a need to foster cross-border

(4)

participation in capacity mechanism design (ENTSO-E, 2015, p.7). However, several member states such as Germany and Belgium have opted to deploy capacity mechanisms in the form of strategic reserves, which according to current EU guidelines are exempt from market participation and emission limits (Simon, 2018, “Germany's 'strategic reserves' for coal under fire”). Therefore, it is relevant to look at this challenge of capacity mechanisms and see the extent to which privatization of electricity markets has had an impact on the generation adequacy concerns in various EU member states.

1.2 EU

O

BJECTIVES AND THE

‘E

NERGY

T

RIANGLE

’

Another factor that requires research is the growing role of renewable energy sources in EU markets and their impact on the capacity mechanism deployment. European Union has introduced ambitious climate and energy policies to minimize the carbon footprint of its energy generation and to phase-out fossil fuel based power plants. The plans are accompanied by objectives to substantially increase the share of renewable sources of energy in Europe’s electricity supply. Altogether, the three EU primary objectives in relation to energy policy – energy security, sustainability and competitiveness have been labelled as the ‘energy policy triangle’ of the EU (Szulecki et al. 2016, p. 549). Thus, EU institutions such as the EU Commission have been eager to establish guidelines according to which Member States have to establish their energy policy in relation to increasing share of renewables and fostering cross-border trade of electricity in order to establish a functioning single electricity market. Since 1980s, the Western states have also introduced market reforms to privatize many sectors which can be considered part of critical infrastructures (Dunn-Cavelty and Suter, 2009). Similarly, the EU shares these market-oriented liberal objectives as it pursues to establish a single market and in order to maximize cost-efficiency and flexibility in price formation and ensure competition throughout the Union (van der Burg and Whitley, 2016). Electricity generation is no exception to this trend. Consequently, state intervention in these markets is generally viewed as a controversial topic in light of these EU objectives. Hence, it is also important to understand whether the on-going energy transition affects the deployment of capacity mechanisms, and in addition, how do national capacity mechanisms fit into the general EU objectives in relation to the ‘energy triangle’ and the effort to establish an integrated energy union.

(5)

1.3 R

ESEARCH

Q

UESTION

Given the debate around capacity mechanisms and their role in EU electricity markets as well as their seemingly contradictory impact on the advancement of EU objectives in relation to climate, market and crisis management policies, the following paper proposes the question:

To what extent do the problems related to electricity market liberalization and energy transition explain why certain EU member states have taken a more intergovernmentalist approach and have decided to deploy capacity mechanisms for the provision of their security of electricity supply?

The following thesis analyses the debate around capacity mechanisms and why certain EU member states have opted to, and conversely why some states have not, deploy capacity mechanisms. It introduces the main types of capacity mechanisms, the debate around them and analyses the debate with the use of theories of intergovernmentalism and European policies in relation to market, sustainability and security, the ‘Energy Triangle’. Finally, the thesis proceeds to study cases of two member states, Germany and Belgium, by analyzing the underlying reasons in their energy markets and why these member states have decided in favor of capacity mechanisms in order secure their resource adequacy. By doing content analysis on the EU Commission decisions on German and Belgian plans to introduce these capacity mechanisms, it attempts to investigate to what extent market liberalization and energy transition can explain this development.

1.4 A

CADEMIC

R

ELEVANCE AND

S

OCIETAL

R

ELEVANCE

Academic

Increasing discussion over the role of capacity mechanisms and their impact on electricity markets, competition as well as the climate and energy objectives of EU and the Member States. Energy, being at the heart of contemporary society, is at the center of core state powers and domestic and international politics of nation-states. As a result, nation states are reluctant to hand over sovereignty of such critical sector to other actors. Nevertheless, since the 1980s, several critical elements of the energy market have been privatized in Western states due to the dominance of neoliberal economic policies and the belief in the markets ability to allocate resources and reach high levels of efficiency than state actors ever could. Privatized critical infrastructure is becoming an increasingly heated debate not only in the context of energy but also in other sectors from cyber

(6)

to water distributions due to the seemingly diverging interests between society and private companies and their shareholders.

The question over the deployment of capacity mechanisms and the reasons for their deployment also tries to contribute to this debate and examine whether market liberalization has led to the deployment of the mechanisms in the first place and whether the interest to secure the nation’s electricity supply with such measures stems primarily from the failures of the market to do just that. As Bublitz et al. (2019) state, “a reliable electricity system remains one of the main objectives of energy market regulators.” (p.1059) It is important to research the existing literature and examine how recent events in energy markets, such as growing role of renewables, phasing out of conventional electricity generation plants, liberalization of energy markets and the increasing transnational interdependency between states in electricity markets impact this fundamental aspect of electricity systems across EU. Researching these factors in the context of growing intergovernmentalism across EU could uncover some of the motivations why several have or have not decided to implement capacity mechanisms in their domestic electricity markets. Furthermore, these have consequences for the EU’s capability to coordinate transboundary crisis management. Boin (2018) claims that “it is important to study different guises in which transboundary crisis comes”. (p.6) Hence, studying the domain of electricity markets in EU and the tension between national sovereignty and establishment of transboundary crisis management capabilities as well as the buildup of a union-wide electricity markets can give us an insightful case study into the field.

Societal

Security of electricity supply and the concerns around it, meanwhile, are crucial questions to which states have to find answers to in order to meet the demands for electricity and avoid blackouts. Blackouts, such as the one in North America in 2003 (Barron, 2003), or a more recent one in Argentina and Chile in June 2019 (Phillips, 2019), have shown that states are vulnerable to such events and the consequences of such blackouts can halt societies to a standstill. Economic impact of such events can be devastating in the modern world. Electricity blackouts in South Africa which occurred in February and March 2019 cost the South African economy in excess of 2 billion euros (Mitton and James, 2019.

Meanwhile, the thesis delves into the topic relating to climate change and the importance of on-going energy transition and its impact of security of electricity supply. EU is pursuing ambitious plans to promote the use of renewables in order to meet these climate objectives, as stated in the Clean Energy for All Europeans Package of 2016, which promises to make EU a global leader in energy transition by reducing greenhouse gases and emissions whilst increasing the

(7)

share of renewables and increasing efficiency (European Commission, 2016). As states are required to follow energy guidelines in order to meet climate objectives and counter the effects of climate change, they are restricted on the methods they can take to secure their security of supply, which could lead to challenges, especially during peak demand. EU is aiming to place itself as a front-runner in climate policies, which is also evident from the political guidelines of the of the new European Commission that were published in November 2019. These guidelines explicitly place climate, energy and sustainability at the core of European policy and proposes that Europe should become “world’s first climate-neutral continent.” (“A Union that strives for more”) Furthermore, in November 2019 European Parliament declared climate emergency to emphasize the need to push forward environmental policies more aggressively and swiftly (“The European parliament Declares Climate Emergency”).

(8)

2. T

HEORETICAL

F

RAMEWORK

The following chapter will delve into a theoretical discussion in relation to the trinity of European Union’s energy policy, or European ‘energy triangle’, which aims to create a unified EU energy union with the emphasis on environment, unified market and economic competitiveness as well as energy security.

2.1 C

HALLENGES OF THE

E

UROPEAN

‘E

NERGY

T

RIANGLE

’

The EU energy policy and the ambitions to establish an integrated energy union across the continent are built upon three fundamental variables, hence why it is referred to as the ‘Energy Triangle’ of the EU (Szulecki et al., 2016, p.549). First, the EU policy emphasizes the importance of sustainability and the roadmap to carbon neutral EU by 2050 (Meeus et al., 2012). EU is aspiring to become a leader in climate-friendly technologies and show the way for a sustainable future in order to counter and prevent the devastating consequences what climate change could cause should the emission levels drop considerably. Second, the EU policy is built upon the notion of free, competitive market that allows companies to offer their services to the clientele at a lowest possible prices, therefore fostering competition and innovation (This ideological direction is also visible in the electricity markets, where EU institutions and the Commission are actively trying to promote liberalization of electricity infrastructures and markets and remove barriers for cross-border trade and competition (European Commission, “Competition”). Third, the essential nature of electricity and security of supply to contemporary societies and economies means that energy security is at the core of European policy relating to energy. As explained earlier, the challenges member states are facing and the reasons stated previously, generation adequacy and reliable capacity is necessary for the energy union to function properly. These three factors together make up the core of EU energy policy and they are in often also at the core of individual member states policy agendas as well. However, as Szulecki et al. (2016) observe, member states differ in terms of which aspects of the energy triangle they prioritize, and this tension can challenge the way EU can push forward new policies and the way member states can achieve consensus on the policy matters in regards to the integration of EU electricity markets and creation of the energy union based on these three principles.

(9)

2.1.1ENERGY TRANSITION AND CLIMATE OBJECTIVES

The Energy Triangle faces challenges to all of its three aspects, to the extent where it is questionable whether these three objectives can be achieved simultaneously. First, the EU policy objectives concerning sustainability are ambitious but also present their own set of challenges, especially in relation to the two other variables that make up the ‘Energy Triangle’. The contemporary EU energy and climate policy is based on the objective of utilizing more environmentally friendly energy and electricity generation methods, and eventually, to reach zero carbon emissions in order to curb the threats of climate change and environmental harm. The member states have accepted the strict EU guidelines on environmental and energy policies and some member states have even proposed stricter environmental and energy standards than what the Union requires. States have increasing their utilization of renewable energy sources whilst phasing out conventional energy sources such nuclear and coal, promoting recycling and encouraging investment in environmentally friendly technologies in order to meet these objectives. Nevertheless, there have been concerns over how realistic these objectives are given the current investment rates and whether it is possible to maintain security of supply solely with renewable sources of energy. Blazquez et al. (2018) have introduced the concept of ‘Renewable energy policy Paradox’ which states that as renewables gain a larger share of the energy supply of a liberalized economy, their intermittent nature – meaning that they are not a constant source of energy but rather fluctuating due to the changes in weather and the availability of e.g. solar and wind electricity – leads to price volatility and together with short-term (near) zero marginal costs they discourage investment to electricity generation. In turn, low investment in electricity generation capacity, which has been referred to as the ‘missing money problem’, has been among the possible key factors that have led to the deployment of capacity mechanisms (EPRS, 2017). Conversely, some of these capacity mechanisms have come under fire, such as the use of coal as strategic reserves in Germany, as this type of capacity mechanisms is exempt from the general emission requirements (Simon, 2018, “Germany's 'strategic reserves' for coal under fire”). As a result, Climate Action Network Europe has raised concerns over how “the current and future widespread introduction of capacity mechanisms would run counter to the EU’s decarbonization objectives.” (2017, p.1)

2.1.2INTERNAL ENERGY MARKET AND COMPETITIVENESS

The second aspect of EU Energy Triangle is the development of a common energy market and the promotion of privatization and liberalization in the energy and electricity markets in order to maximize the utilization of resources and fostering competition while offering electricity to the

(10)

end-user at a lowest possible price. Since the 1980s, there has been an increasing encouragement from the Member States to allow private enterprises to takeover electricity generation and electricity grids as well as building a more transnational electricity network that spans throughout the EU (“Benefits of an Integrated European Energy Market”, 2013).

However, due to the lack of investment in electricity generation, capacity mechanisms have received state aid as member states remunerate the creation of these backup generation capacities. Moreover, the existing EU State Aid Guidelines by European Commission (2014) also require the capacity mechanisms to fulfil certain criteria, such as undergoing assessment to inquire whether there is need for capacity mechanisms in the first place as well as criteria over competition and how capacity mechanisms impact EU’s internal market in order to qualify for state aid. The European Commission views the capacity mechanisms essentially as “necessary evil during the EU’s transition to a cleaner energy system” (Simon and Hodgson, 2018) It remains to be seen whether capacity mechanisms will be a temporary solution or a more permanent feature in EU energy policy and the nature of the renewable energy sources raises questions over whether EU can meet its objectives without the lasting presence of capacity mechanisms. EU Commission, in particular, has been critical over the role of capacity mechanisms in the internal energy market due to the possible distortions to competitiveness as well as to cross-border trade of electricity. Another issue that has distorted the cross-border trade of electricity has been the lack of investment in interconnectors, and as a result states face difficulties in trading surplus electricity across borders (Leinen and Langen, 2018).

2.1.3ENERGY SECURITY AND CRISIS MANAGEMENT

Finally arises the question of security which a key component of EU Energy Triangle. However, as stated above, the challenges created by the environmental objectives and market conditions have raised concerns over the ability provide electricity during peak demand period. This also fits into the general EU objectives in building transnational crisis management capabilities as such concerns over security of supply are not limited to only one member state and the possible repercussions of a blackout or similar even could have transnational consequences.

The impact of capacity mechanisms over European transnational crisis management objectives is somewhat questionable since they seem to be largely a national solution to a transnational problem. As previously discussed, due to the transnational threat landscape, crises are no longer viewed as solely the responsibility of the individual member and it is expected that member states coordinate their crisis management efforts to counter the risks more effectively. Boin, Rhinard and Ekengren observe that “over the years, the European Union (EU) has built a

(11)

variety of capacities to coordinate the response of member states to natural disasters and foreign crises.” (2014, p.131) Moreover, they state that “the world – especially Europe – has become too connected and too intertwined to avoid the reach of these crises. It has become nearly impossible to close borders and ‘decouple’ critical infrastructures.” (p. 132) It is, however, questionable how much national capacity mechanisms contribute to the crisis management and crisis response capabilities of the EU due to the current lack of cross-border participation and coordination. Capacity mechanisms, after all, are primarily a crisis management tool for countering any potential national crisis in relation to the security of supply and yet they have transboundary implications on EU energy security and electricity markets. Moreover, in light what has been discussed an explained prior in relation to the increasing share of renewables and the necessity of contemporary capacity mechanism, some could also argue that capacity mechanisms will remain a permanent feature in EU energy policy rather than a temporary solution to ease energy transition. The hypothesis in the research is that national capacity mechanisms have a role in driving the integration of EU electricity networks and can be regarded as a necessary feature in driving energy transition and possibly will remain a permanent feature in EU electricity markets.

As the world is developing increasingly interconnected and complex, also crisis such as electricity shortages are no longer restricted by national boundaries but instead can spread internationally and have transboundary implications as a consequence. Transboundary crisis, according to Arjen Boin (2018), are crisis that come a foreign origin but which “effortlessly exceed geographical, policy, cultural, public-private and legal boundaries that normally enable public managers to classify, contain and manage a crisis.” (p.1) In other words, they require the coordination of multiple outside of the local actors due to the nature of these crisis. Boin demonstrates transboundary crisis by referring the SARS epidemic of 2002, financial crisis of 2008, the 2010 volcanic eruption in Iceland that had devastating effect on Europe’s aviation operations as well as the refugee crisis of 2015 – all examples of crisis that transcend national borders and affect many actors regionally and/or globally. Consequently, Cabane and Lodge have claimed that “addressing transboundary crises represents one of the key societal challenges facing Europe.” (2018, p.6) Another domain where regional coordination is increasing in demand is energy as electricity grids across the Europe are becoming more sophisticated and interlinked. Therefore, efforts to prevent crisis, such as blackouts and electricity shortages, are being considered across the continent as such crisis can have an impact that goes beyond national borders and such crisis could overwhelm a single member state and thus require a regional and transnational coordination. The increasing complexity and interconnectedness of European electricity networks poses a challenge to the security of supply of the Member States as well as to the EU as a whole – perhaps

(12)

a challenge that cannot be solved with domestic solutions such as capacity mechanisms. Therefore, the extent to which capacity mechanisms can exist in the internal energy market, and whether their utilization can be coordinated transnationally, remains to be seen.

2.2 I

NTERGOVERNMENTALISM IN THE

E

UROPEAN

U

NION

Another essential notion in debate around capacity mechanisms, considering that they are largely a national solution without top-down coordination and promotion from EU supranational institutions, is the role of intergovernmentalism in the European Union, and particularly in domains related to crisis management, energy security and core powers of the state. In 1993, Andrew Moravcsik introduced the well-known theory of liberal intergovernmentalism which according to him is based upon three assumptions: rationality of the state actors, national preference formation and intergovernmental international bargaining and negotiation. Such responses have been witnessed before in the midst of great threat for the EU and for the member states such as in the case of the Eurocrisis during which ordinary measures would have been deemed insufficient and as a result member states took the leading role through the means of intergovernmental bargaining in order to secure the future of the Eurozone (Hooghe and Marks, 2019, p.6) Here we see not only the emergency responses taken in order secure the Eurozone during the crisis but as a response to market failures that led to the crisis in the first place. Could it be that the deployment of capacity mechanisms can be explain using the same logic of increasing intergovernmentalism bargaining primarily as a response to failures of the market in order to secure the functioning of a critical sector within the society? Therefore, the thesis proposes the following question: how can theory of integovernmentalism explain why certain states have implemented such measures as capacity mechanisms for the provision of their security of electricity supply?

In the context of energy, which is at the center of high politics and core state powers, member states are reluctant to hand over sovereignty to supranational institutions. Goldthau and Sitter (2014) argued that the EU Commission is a liberal actor in a realist world in relation to its ambitious external energy policy. Could it be argued that EU Commission has also become a liberal actor in a realist world when it comes to the internal energy market of the European Union? Certainly, the recent efforts of the Member States and the EU Council to emphasize sovereignty of the Member States over their security of supply and the deployment of capacity mechanisms seems to suggest that EU Commission is unable to meet its own objectives in terms of a market-only solution for internal energy market and security of supply. According to the intergovernmental scholars, “state preferences should be fundamental for the negotiations outcome and these are shaped by domestic economic interests.” (Szulecki et al. 2016, p.560)

(13)

To some, post-Maastricht era represents a paradox in European integration as Member States push for further integration but “stubbornly resist further supranationalism.” (Bickerton, Hodson and Puetter, 2015, p.5) Therefore, Puetter (2014) argues that whilst European integration in last 30 years has been unprecedented, ‘new intergovernmentalism’ has in fact been on the rise since the signing of Maastricht Treaty of 1992 as EU Council and the representatives of the Member States have the leading role in decision-making in new areas of EU activity. In the case of energy policy, we witness the role of Member States and their interest in having control over own domestic security of supply. Moreover, the deployment of capacity mechanisms as a response to underlying existential threats to energy security aligns with other similar emergency responses such as the Eurocrisis which have relied primarily on intergovernmentalist bargaining. Thus, according to Szulecki et al. (2016), “ongoing Europeanization of energy policy could be resisted by governments” (p.560), as states see sovereignty over own energy security as primary objective of the Member State whereas the EU Commission believes in the market-based solution on securing energy security within the internal energy market. On the contrary, Thaler (2016) states that the new intergovernmentalism in creation of Energy Union does not necessarily entail competition between the Council and the Commission but rather a “readjustment of working mechanisms of the two key actors that have resulted in a more cooperative relationship and concerted action.” (p.583) In other words, the two cooperate on policies based on the competencies and use their institutional advantages in the creation of policies rather than entirely retreat political power from one to another. Both have their own strengths and weaknesses which will be used accordingly in process of decision-making.

Some scholars argue that the approaches are also tied to the national situation, which affect the policy preferences of the given member state. Genschen and Jachtenfuchs (2017) observe that in the case of the refugee crisis and Eurozone crisis, the EU states divided into two camps, one demanding tighter regulation and the other further capacity-building. Similar stand-off between two camps could perhaps also be expected in the field of electricity and crisis management, division depending on the abilities and severity of the crisis unfolding on their territory. Genschen and Jachtenfucs (2017) explained this division in the case of refugee crisis by how fortunate or unfortunate the states had been during the crisis, i.e. which states were the first and most affected and observed the differences in their policy preferences from these outcomes. The thesis will look into the cases several member states in Chapter 4 to establish whether these factors can play a role affect the policy preferences, as in this case, the opinion towards national capacity mechanisms and whether their deployment can be viewed compatible in the context of EU energy policy objectives or not. Moreover, the thesis will question whether, given the priority

(14)

of security of electricity supply for national policy-makers as well as the differing national situations related to electricity markets and generation adequacy, member states can coordinate on the issue.

2.3 P

RIVATIZATION OF

C

RITICAL

I

NFRASTRUCTURE IN

E

UROPEAN

U

NION

Furthermore, the nature of critical infrastructures in the European Union has changed considerably in last few decades as these have increasingly shifted towards private ownership. Since 1980s, a new consensus on economic policy in the midst of European policy makers and business interests arrived, focusing on deregulation and liberalization in order to bring about increased economic efficiency (Renn and Marshall, 2016) Since then, economic reforms have gradually taken place across the continent as new sectors have taken place in alignment with this economic doctrine (Dunn-Cavelty and Suter, 2009). This also affected electricity markets which were previously highly regulated and in control of public monopolies (Renn and Marshall, 2016) Although, this development has varied depending on the form of electricity production, and Renn and Marshall observe that nuclear power in particular has been highly protected industry “as its ability to raise capital from private investors was limited due to the uncertainty associated with large up-front investment costs, insurance costs, and uncertainty about licensing over its life span.” (p. 225) Nevertheless, today electricity markets across Europe are primarily in private hands (van der Burg and Whitley, 2016).

However, privatization of sectors relating to critical infrastructure has become an increasingly contested topic in recent years in societies where ownership of services such as telecommunication, electricity generation, electricity grids and water supply have moved to the possession of private enterprises since 1980. Following the process of privatization and liberalization comes the challenge to create “incentive structures to motive private enterprises to not only focus on shareholder value, but to take social objectives into account.” (Burger and Weinmann, 2019, p.3) In the context to energy and electricity, such incentives have to exist in order for the private entities to invest properties of electricity market that affect security of electricity supply and society’s constant access to electricity at all times. However, as backup generation capacity is generally not viewed as profitable, such investments might be lacking due to lack of incentive for investment. After all, private enterprises might have other priorities than public entities in mind. Therefore, a question arises over contemporary electricity markets capability to maintain energy generation adequacy and provide energy security in liberalized economies, and whether capacity mechanisms are a permanent or only a temporary solution to this challenge. Consequently, the thesis enquires whether the three objectives of the EU energy

(15)

triangle are in fact mutually compatible, or if (national) capacity mechanisms are a necessity to encounter the challenges introduced by liberalized electricity markets and intermittent renewable energy sources.

(16)

3. R

ESEARCH

D

ESIGN

Chapter 3 of the research paper provides the outline for the research that will take place in the following chapters and explains the methodologies that will be utilized to answer the research question that was proposed in Chapter 1.

3.1 C

OMPARATIVE

C

ASE

S

TUDY

First, the research will utilize a comparative case study which will examine the energy policies of two EU Member States, Germany and Belgium, as well as their argumentation over the conditions which have contributed to the deployment of capacity mechanisms. More specifically, the case study will focus on the plans over deployment of strategic reserves which were approved by the EU Commission in 2018. The comparison of these two particular member states is interesting for several reasons. First, Belgium and Germany are currently at different stages in their domestic energy transition, with the former currently producing substantially smaller portion of its electricity output from renewable energy sources. German energy policy, the so-called Energiewende, has increasingly emphasized increasing the role renewable energy sources and the phasing-out of nuclear and fossil fuel based energy production capacity (Renn and Marshall, 2016) However, deployment of capacity mechanisms could also contradict EU energy and climate objectives if fossil fuel based capacity, as in the case of Germany, is used as a capacity mechanism (EPRS, 2017). Meanwhile, Belgian energy policy has not focused on the energy transition as much in recent years although plans exists to speed up transition in the coming years. Secondly, both member states are among the leading advocates of EU integration and consequently deployment of capacity mechanisms, which has been questioned by both EU Commission as well as several shareholders, is interesting as it emphasizes national sovereignty over security of electricity supply rather than utilizing more transnational policy options such as cross-border trade to secure energy adequacy.

3.2 C

ASE

S

ELECTION AND

S

AMPLING

The case study in question is a cross-case case study where the primary aim is to identify causal relationship between electricity market liberalization, energy transition and deployment of capacity mechanisms. As Rohlfing (2012) states, cross-case level “is the level on which a causal effect is theorized and examined.” (p.12) The case study will use a distribution-based case study selection where typical cases of member states above and below EU28 average in share of renewable energy

(17)

will be evaluated. It is a typical cross-case study where first member state, Germany, is situated above EU28 average in share of renewable energy sources as total energy output and the second, Belgium, is situated below the EU28 average. Both member states’ renewable energy output represents roughly the average in their respective categories of ‘high share’ and ‘low share’ of renewable energy sources. Such case selection is utilized in order to better explore the causal relationship and it may also be utilized to disconfirm a general causal proposition (Seawright and Gerring, 2008). Meanwhile, other factors, such as liberalization of electricity market policies, economic factors being fairly equal, the aim is to test whether investigate further whether that EU member states are opting to deploy capacity mechanisms primarily due to market failures and lack of investment in backup electricity production or due to increasing usage of renewables and phasing out of conventional generation capacity.

Figure 1: The Development of Renewable Energy Share in Belgium, Germany and EU28

Source: Data from Eurostat, 2018 http://appsso.eurostat.ec.europa.eu/nui/submitViewTableAction.do

As the case study utilizes distribution-based case selection of typical cases, it aims to offer an explanation of the results of the comparative case study to all cases within the category. The scope conditions of being an EU member state and having deployed or having announced plans to deploy capacity mechanisms limit the size of the population to only 11. In total the sample size

0.0 5.0 10.0 15.0 20.0 25.0 30.0 35.0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Share of renewable energy in electricity, 2007-2016

(18)

of two member states they represent roughly 7% of the 28 member states in the EU, and roughly 18% of the 11 member states in the EU which have deployed or have announced plans to deploy capacity mechanisms. However, a challenge that is facing the research is the number of EU member states that have not deployed capacity mechanisms and whether their respective reasons for not deploying them also confirm the hypothesis of the case study. Rohlfing describes a strategy of layered generalizations as a way of further validating a hypothesis by lifting scope conditions and introducing new sample cases to the population (2012, p. 205). Therefore, the chapter 4 of the thesis focuses on analyzing the debate in Europe around capacity mechanisms in an effort to observe reasons why certain states have both argued against capacity mechanisms and decided not to deploy them to secure their own resource adequacy. By doing so, analyzing the debate could offer additional arguments to examine the hypothesis as well as increase the thesis’ external validity.

3.3 C

ONTENT

A

NALYSIS

The comparative case study will be accompanied by a content analysis, which is utilized in order to identify reasons for the deployment of capacity mechanisms and how Member States have argued for their case. The content analysis will focus on the EU Commission decision documents from February 2018 where the Commission approved the plans of several member states, including Belgium and Germany, to deploy capacity mechanisms. These documents reveal not only the justifications used by the two member states to deploy capacity mechanisms but also the line of reasoning why the Commission has, somewhat controversially, approved these plans. Furthermore, the research will look into the domestic situation of both member states to evaluate the need for such measures based on additional sources. Content analysis on the EU documents is particularly useful for the research as it tries to identify objective indicators and thus ensures the reproducibility of the research. Content analysis on the Member States in question will be based on two categories; 1) market-based reasons such as market failures or lack of investment in backup generation capacity, and 2) energy transition-based reasons, which argue for the capacity mechanisms due to ongoing energy transition and phasing out of existing generation capacity (Appendix A). Moreover, the analysis will emphasize whether the plans have been approved for a short-term usage and not and if their purpose is to compensate for lack of capacity during a specific period within the calendar year such as peak-demand seasons in the winter. The general idea is to identify patterns for each Member State, both for those who have decided to deploy capacity mechanisms and for those who have decided against them in order to recognize similarities and differences in the line of argument of the Member States. This, in return, will allow the thesis to analyze the extent to which the interests of the Member States have been fulfilled in comparison

(19)

to the interests of the EU Commission and its energy objectives. In the case of content analysis is not the member states but rather paragraphs and/or quasi-sentences within the relevant documents from archives of EU, from the representative transmission system operators (TSOs) of these particular Member States as well as from ENTSO-E that represents the TSOs at the EU-level.

(20)

4. E

UROPEAN

D

EBATE ON

C

APACITY

M

ECHANISMS

Chapter 4 introduces the main types of capacity mechanisms in the EU, the general arguments for why they are implemented and adds an European-wide discussion on capacity mechanisms and the states in favor and against capacity mechanisms to provide context for the paper before introducing the analytical discussion chapter and the research on two case studies.

4.1 I

NTRODUCTION TO

C

APACITY

M

ECHANISMS

The following section introduces the types of capacity mechanisms implemented or planned in the EU, their designs and how they differ from one another. The principal idea behind the implementation of a capacity mechanism is to “improve the resource adequacy of the system by maintaining sufficient reserve margins.” (Bhagwat, Vries and Hobbs, 2016, p.12) This means the additional generation capacity is created as a preparation for electricity shortage scenarios as electricity markets are assumed to be unable to fully respond to peak demand periods with their pricing. Bhagwat, Vries and Hobbs add that in addition to ‘missing money problems’, “price caps, the absence of shortage pricing, long averaging periods, or other reasons, energy and ancillary service prices may fail to reflect the full value of power.” (p.12) As a result, this may result in reserve capacity being unattractive to investors and could lead to lack of investment in generation capacity. On the other hand, these markets could be distorted further by capacity mechanisms, which could lead to increasing reliance on capacity mechanisms over time.

Capacity renumeration mechanisms, as they are referred to by the Agency for the Cooperation of Energy Regulators (ACER) can be divided into two distinct categories, volume-based and price volume-based mechanisms. Whereas volume-volume-based capacity renumeration mechanisms rely on policy-makes defining the necessary capacity volume and allow electricity markets to determine the price, price-based capacity renumeration mechanisms rely on policy-makers determining the price and let the market entities decided the exact amount of volume they want to deploy for that price (EPRS, 2017, p.3) An example of price-based capacity renumeration mechanisms is capacity payments. Meanwhile, volume based capacity renumeration mechanisms can be divided into two further subgroups, targeted and market-wide mechanisms. Key difference between targeted and market-wide capacity renumeration mechanisms is that targeted mechanisms utilize only certain plants and technologies whilst market-wide mechanisms allow all technologies and plants to be rewarded (EPRS, 2017, p.3) Strategic reserves are a type of targeted mechanisms where as other volume based mechanisms such as capacity obligations, capacity auctions and reliability options are types of market-wide renumeration mechanisms.

(21)

This chapter will primarily explain the differences between different volume-based capacity renumeration mechanisms. First, and perhaps also the most controversial one, are strategic reserves. These are capacity reserves that are kept outside of the market for emergency situations. These situations are “signaled by prices in the day-ahead, intra-day or balancing markets increasing above a certain threshold level.” (ACER, 2013, p.5) The volume of a needed strategic reserve is calculated by the local TSO. These strategic reserves can be found in EU member states such as Belgium, Germany, Poland, Finland, Lithuania and Sweden (Bublitz et al., 2019). Strategic reserves are also and are exempt from emission limits, as we can see in the case of Germany, for example, which has become a controversial topic, with several stakeholders considering these as a regulatory loop hole in regards the general aims to reducing emission levels and achieve carbon neutrality by 2050.

Second type of capacity renumeration mechanisms is capacity auctions, which are auctioned capacity that is determined few years in advanced, and capacity providers are remunerated on the basis of how much it costs to build new capacity (EPRS, 2017, p.4). The auction is secured by an independent entity and the price of the capacity is set by a forward auction and the renumeration is paid to all successful auction participants (ACER, 2013, p.6). The UK is an example of a member state that has deployed a capacity auction. Third, capacity obligation a decentralized obligation placed on load-serving entities to meet the customer’s demand for capacity, that unlike a capacity auction is not centrally auctioned but rather negotiated individually with capacity providers (Bublitz et al., 2019, 1063). Such renumeration mechanisms is utilized in France. Fourth, reliability options are renumeration instruments that incentivize capacity providers to keep capacity available during scarcity periods by remunerating a fixed fee to the capacity providers whenever the wholesale market price is higher than pre-set reference price that is set in the contract (ACER, 2013, p.6). Finally, there are capacity payments. As mentioned previously, these are a type of price based capacity renumeration mechanisms. Capacity payments are fixed price payments to contracted capacity providers and quantity of the capacity is decided by market actors (ACER, 2013, p.7). Spain, Portugal and Italy are member states in the EU that have deployed their own capacity payment mechanisms (ACER, 2013, p.8).

(22)

Figure 2: Types of Capacity Mechanisms Deployed in Europe

Type Description Countries where

implemented

Strategic reserve Emergency reserve capacity kept outside of the

market, to be deployed only in “exceptional circumstances” (ACER, 2013, p.5).

Belgium, Germany, Poland, Sweden

Capacity auction Capacity auctions rely on auctioned capacity that

is determined several years prior deployment, and capacity providers are remunerated on the basis of how much it costs to build new capacity (EPRS, 2017, p.4)

UK

Capacity obligation A decentralized obligation placed on

load-serving entities to meet the customer’s demand for capacity, that unlike a capacity auction is not centrally auctioned but rather negotiated individually with capacity providers (Bublitz et al., 2019, 1063)

France

Reliability options Renumeration instruments that incentivize

capacity providers to keep capacity available during scarcity periods by remunerating a fixed fee to the capacity providers whenever the wholesale market price is higher than pre-set reference price that is set in the contract (ACER, 2013, p.6).

Italy (planned)

Capacity payments Fixed price payments to capacity providers,

where quantity of the capacity is decided by market actors (ACER, 2013, p.7)

Italy, Portugal, Poland, Spain, Ireland

4.2 C

APACITY

M

ECHANISMS IN

E

UROPEAN

U

NION

In the European Union, choice of capacity mechanism design and its implementation is in the hands of the member states, which can lead to a situation where each member state has a different

(23)

capacity mechanism design from one another (Bhagwat, Vries and Hobbs, 2016, p.12). As such, capacity markets in the EU are inherently uncoordinated from top down and can thus lead to issues regarding between member states cross-border trade and market distortions, as well as tensions in relation to the design of capacity mechanisms as each member state implementing a capacity mechanism have their own preferences due to differing domestic conditions. Bublitz et al. (2019) states that cross-border market distortions could appear if capacity mechanisms are deployed without consideration for generation capacities abroad (p.1072). However, ENTSO-E is trying to promote closer collaboration and cooperation between different national TSOs as well as other stakeholders in order to make capacity mechanisms less detrimental to cross-border trade (ENTSO-E, 2015).

Capacity mechanism have become a topic of continuous debate at the European level where member states and other stakeholders alike have questioned both member states’ plans to introduce varying types of capacity mechanisms as well as the Commission’s decisions to approve these plans. A recent example would be the Commission’s approval of Poland’s plans for new capacity mechanisms which was challenged by Tempus Energy in March 2019 who argues that Commission has approved such plans “without consulting other market players”, which “prevents other energy operators from highlighting flaws in the scheme.” (“European Commission’s decision to approve Poland’s capacity mechanism challenged”, 2019) Even though each plan are submitted in accordance with EU state aid guidelines and national TSOs own assessment over need for generation adequacy, it is noteworthy that different EU member states do indeed utilize different adequacy assessment criteria and methodology, which can lead to varying estimations and forecasts over adequacy needs. (ACER, 2013). Meanwhile, other stakeholders such as NGOs like Climate Action have also expressed their concerns over deployment of capacity mechanisms in EU, claiming that they are largely subsidizing environmentally harmful generation plants (Climate Action Network Europe, 2017, “CAN Europe Position on Capacity Mechanisms”).

4.3 M

EMBER

S

TATES IN

F

AVOR OF

C

APACITY

M

ECHANISMS

Many member states in the European Union, in addition to Germany and Belgium whose cases will be covered extensively in Chapter 5, have decided to implement capacity mechanisms in recent years due to numerous domestic conditions. Leiren et al. (2019) state that that UK, France and Poland have “prioritized national capacity mechanisms and developed them with domestic interests in mind.” (p.100). As explained in section 4.2 of this chapter, implementation of capacity mechanisms is a process driven by domestic conditions, and consequently member states consider their own interests and own conditions, and proceed to implement a capacity mechanisms that

(24)

suit their purposes rather than coordinate the implementation with their neighboring states. Leiren et al. continue by adding that in the case of these three states, the underlying reasons for the introducing capacity mechanisms is not due to energy transition or because the need for a creation of backup generation capacity for intermittent renewable energy sources, but rather due to domestic market conditions and market failures which have led to by lack of investment in generation capacity (p.100). This notion challenges the argumentation that capacity mechanisms are primarily a backup source for intermittent energy sources during peak demand seasons and instead brings forward the question over capacity adequacy in liberalized electricity markets such as those in Western Europe.

In the case of France, since 2000 the domestic winter peak demand electricity consumption has increased “significantly” while conventional capacity generation capacity such as oil and coal plants are being closed, and consequently the French have even gone as far as to claim that capacity mechanisms are now “essential” for security of electricity supply and in order to attract investment in new capacity (Schwarz, 2018, “Why France Believes Capacity Mechanisms Are Necessary”). The growing role of intermittent sources is only going to underline this fact rather than explained the need for capacity mechanisms entirely. However, unlike some other member states, France utilizes a market-participatory capacity mechanisms that allows the market to “set the price of capacity guarantees in a decentralized way, and to allow each supplier to cover at the best price the level of capacity obligation resulting from their clients’ consumption.” (Schwarz, 2018, “Why France Believes Capacity Mechanisms Are Necessary”). The French solution, which is a demand response, decentralized capacity obligation, a design which can also be found in Greece, incentivizes consumers to reduce consumption during peak demand rather than produce additional electricity as is with other types of capacity mechanisms (European Commission, 2018, “State Aid: Commission Approves Six Electricity Capacity Mechanisms”). In the context of wide variety of capacity mechanisms introduced in EU, the French solution seems to align with the EU energy triangle better than most other capacity mechanisms operated in different member states. Also, in the EU State Aid Guidelines Article 220, it is stated that alternatives “such as facilitating demand side management and increasing interconnection capacity” is preferred over establishing new capacity or maintaining existing, and potentially polluting capacity generation means, as backup generation (European Commission, 2014, “Communication from the Commission – Guidelines on State Aid for Environmental Protection and Energy 2014-2020”).

Meanwhile, the UK capacity mechanism, which was originally approved in 2014, was suspended in 2018 after questions over its compliance with EU state aid guidelines emerged. The

(25)

capacity market was cleared to resume in October 2019 after investigation by the Commission into the compliancy issue yielded no evidence towards the scheme distorting the competition or putting any capacity providers in a disadvantageous situation (Stoker, 2019, “UK’s Capacity Market Cleared to Resume by European Commission”). However, Baker and Hogan (2019), senior advisors from Regulatory Assistance Project, an independent organization promoting energy transition, still argue that the plans for the scheme lacks motivation as there is “no evidence to suggest that such mechanism is necessary to bring forward new investment in electricity generation.” (Hogan and Baker, 2019, “UK Capacity Market Déjà Vu: A Solution That’s Still In Search of a Problem”) As it is clear from this clear disagreement about the need for such a scheme, we can observe the controversiality of the topic and how diverse the opinions on the subject are depending on which side of the debate arguments are coming from. Those who are proponents of swift energy transition, and in general promote clean and sustainable energy sources, are more inclined to oppose such schemes as these, despite being technology neutral on paper, often resort to conventional energy sources as the basis for the scheme rather than for renewables.

Similarly, Italy has planned to introduce a market-wide capacity, similar to the design of the UK capacity scheme, and these plans were approved by the Commission in February 2018 after agreeing with Italian justification over a with the assessment about security of supply risks. In addition, the plans for the scheme are approved under the conditions that they meet the “stringent C02 emission limits” set by the Commission (European Commission, 2019, “State Aid: Commission Approves Introduction of Stringent Emission Limits in Italian Capacity Mechanisms”). Whilst approving the Italian scheme, the Commission also approved a similar scheme for Poland who also has underlined the market failures, which prevent “ prices from incentivizing power generators to keep existing capacity in the market or to invest in new capacity.” (European Commission, 2018, “State Aid: Commission Approves Six Electricity Capacity Mechanisms”).

These are just few examples of member states that have deployed their own capacity mechanisms or are planning to do so. In total, 2016 EU Commission Final Report of the Sector Inquiry on Capacity Mechanisms found that there are 35 capacity mechanisms deployed in 11 different member states (European Commission, 2016, “Final Report of the Sector Inquiry on Capacity Mechanisms.”). Meanwhile, many other member states have not (yet) deployed capacity mechanisms. Perhaps the bigger question is therefore why have certain member states seen the need for a capacity mechanisms and which factors explain the conditions that have led these member states to take such a decision to secure their supply of electricity.

(26)

4.4 M

EMBER

S

TATES

O

PPOSING

I

MPLEMENTATION OF

C

APACITY

M

ECHANISMS

Not all EU member states share the same enthusiasm or support for capacity mechanism or regard them as essential feature of secure electricity markets. Moreover, there also exits varying interpretation on capacity mechanisms and whether they are within the means of European energy policy, its objectives and current EU regulation on aspects such as the compatibility with EU state aid regulation. Danish TSO Energinet, for example, whilst recognizing the challenges of decommissioning of conventional power plants has on the security of supply in Denmark, does not advocate for the utilization of capacity mechanisms such as strategic reserves as it believes that these solutions are at odds with the EU state aid regulations (Energinet, 2017, p.8). Energinet did consider introducing capacity mechanisms but decided to cancel these plans as it believed European Commission would not apply such mechanisms. Instead, Energinet pursues to secure the Danish electricity supply via the means of cross-border trading. Danish high investment level in renewables stems from the oil crisis of 1970s where the country that highly dependent on oil exports found its economy being brought to a standstill after the primary source of energy, Saudi Arabia, began oil embargoes (Energistyrelsen, 2012). Ever since, Denmark has been among the leaders in renewable generation. However, as there’s sufficient capacity available via interconnectors, Denmark has decided as against capacity mechanism.

Similarly, the Netherlands has thus far been reluctant to introduce capacity mechanisms primarily due to the fact that Dutch electricity markets are not facing electricity shortage or other adequacy-related issues now or in the near future. In ENTSO-E future forecasts, Netherlands has spare electricity generation in all scenarios unlike many of its neighboring countries such as Germany which is facing adequacy issues in all three future scenarios (Meulman and Méray, 2012, p.20). However, in the Dutch case there are concerns over grid constraints and the impact this will have on deploying more solar and wind power generation capacity should there be no additional investment in electricity grids to alleviate the grid congestion that the country is facing in its northern provinces where more renewable energy capacity is planned to be deployed in the coming years (Bellini, 2019). Interestingly, TNO ‘Towards A Future-Proof Energy System’ report does admit that whilst Netherlands energy sector is currently reliable, the Dutch ambitions of having sustainable, reliable and affordable – which are also the basis of the EU ‘Energy Triangle’ policy – might be not necessarily be “mutually supportive” (Donker et al., 2015). The report therefore proposes the same question as this paper over the energy triangle and possible challenges relating to fulfilling all three objectives.

(27)

Other member states that have decided against capacity mechanisms or have not (yet) seen a need for one include Estonia, Latvia, Czech Republic and Austria. In general, there’s a greater tendency in Eastern Europe to not need capacity mechanisms as adequacy concerns are not as great of a threat as they are in the West. Moreover, many of these states have only recently started liberalizing their electricity markets in the aftermath of the fall of Soviet Union and gaining membership in the EU. However, states such as Latvia, Estonia and Austria are actually among the highest users of renewable energy sources (Eurostat, “Renewable Energy Statistics”), which raises the question over what extent energy transition actually explains the deployment of capacity mechanisms in the EU. This could provide further evidence to findings of Leiren et al. who observed that in the cases of UK, Poland and France, the primary explanation for utilization of capacity mechanisms is lack of investment in capacity generation and infrastructure rather than on-going energy transition and the need for backup generation capacity for intermittent renewables. Moreover, Sweden which is a leader in the utilization of renewables in the EU, has currently deployed a strategic reserve but it will be phased out in 2020 (ACER, 2013, p.8). Either way, in the case of member states who have decided against capacity mechanisms, these also tend to be smaller member states with less bargaining power within the European Union and who have are relying on imported electricity as a backup rather than deploying their sovereign backup capacity mechanisms.

(28)

5. G

ERMAN AND

B

ELGIAN

C

APACITY

M

ECHANISMS

The following section investigates the cases of Germany and Belgium and the 2018 decision by the European Commission to approve their plans to implement capacity mechanisms. The two cases are of particular interest due to utilizing strategic reserves which are excluded for emission requirements and cross-border trade and emphasize the creation of sovereign backup generation. The case selection and research methods used in this section are explained in Chapter 3. The cases of Germany and Belgium are then analyzed through the theoretical framework introduced in Chapter 2.

5.1 G

ERMAN

E

LECTRICITY

M

ARKETS

German energy policy has increasingly attempted a shift away from fossil fuel-based energy sources since 1973 the oil embargo which made Germany realize its reliance on oil from OPEC states. However, increases in the utilization of renewable energy did not take place until late 1990s. In the aftermath of the Fukushima 2011 nuclear accident, German government has taken an effort to phase-out nuclear power in favor of renewable energy sources (Szulecki et al., 2016, p.554). However, German government’s decision to phase out all nuclear plants has placed Germany energy policy under pressure and compromised its efforts to achieve German and EU decarbonization objectives. Until 2010, half of the generated energy was from coal and lignite, and rest from nuclear, gas and renewables but since announcing the Energiewende policy share of nuclear has declined whilst share of renewables has increased (Renn and Marshall, 2016, p.225). Nevertheless, German utilization of lignite has in fact remained stable while share of coal has dropped slightly (“Germany's Coal/Lignite Power Plant Phase Out”, 2019) This has occurred due to phasing out of nuclear and insufficient levels of renewables-based generation capacity. Renn and Marshall (2016) observe that it does seem unlikely Germany would reconsider its stance on nuclear despite the issues its facing relating to increases in electricity prices and concerns over energy security due to volatility in consumption as well as volatility in electricity generation with intermittent energy sources (p.230). This notion is further underlined by more recent events, such as strong German opposition towards including nuclear energy in the EU sustainable finance classification scheme (Valero, 2019).

As a result, Germany is currently facing electricity shortage currently and in the near future. ENTSO-E future forecast models show that Germany faces electricity shortage in all three

(29)

future scenarios that have been established to assess resource adequacy (Meulman and Méray, 2012, p.20). Furthermore, Germany’s interconnectors with neighboring states seem insufficient to secure supply of electricity via cross-border trade. In March 2018, Danish TSO asked the EU to examine German TSO TenneT’s blockage of excess Danish capacity crossing the border to Germany and whether it violates EU antitrust laws (European Commission, 2018, “Antitrust: Commission Invites Comments on TenneT’s Proposed Comments”). In response, TenneT claimed that denying access for Danish electricity was done due to the limits in transmission capacity, which exist due to “market liberalization and transition to renewable energy.” (“UPDATE 1-German grid operator TenneT's cross-border capacity under EU microscope”, 2018) Indeed, German energy policy towards renewables creates new challenges for the German energy grid as new transmission lines have to be built to handle capacity which was not intended to exist when centralized German electricity grid was initially designed and built, and as of now the plans to extend and improve the grid are lagging behind (“German energy regulator says new renewable targets create grid challenges”, 2018). These objectives to increase share of renewables have also generate clear consequences for German households, as they have price of electricity increase by nearly 50% since 2006, despite decrease in wholesale prices of electricity during the same time window, which primarily explained by the increase in renewables surcharge that now accounts over 20% of German household energy bills (Thalman and Wehrmann, 2019).

5.2 G

ERMAN

M

OTIVATION FOR

D

EPLOYING

S

TRATEGIC

R

ESERVES

In February 2018, EU Commission approved the plans for German capacity mechanisms along with five another capacity mechanisms of different types in France, Greece, Italy, Poland and Belgium. The document that will be analyzed in this section is the EU Commission decision on Germany capacity mechanism from February 2018.1_{The German capacity mechanisms is a} 2.7GW lignite-based generation capacity that, due to being a strategic reserve, is exempt from EU emission requirements of 550g CO2/kWh, which has generated fair amount of controversy in the EU (Umbach, 2019, “Threatening EU’s Capacity Mechanisms”). Central to the capacity reserve applications, as well as to the criticism around them, has been their applicability to state aid rules of the EU. The Commission assess proposed capacity mechanisms using six separate criteria to examine their applicability under state aid guidelines. First, the mechanisms must be targeted to a

1_{European Commission (2018, February 7). Commission Decision of 7.2.2018 On The Aid} Scheme SA.45825 – 2017/C (ex 2017/N) which Germany is planning to implement for Capacity

Capacity Mechanisms in EU Electricity Markets: Why Do Member States Implement Them? Analysis on German and Belgian Strategic Reserves