Financing investment in new electricity generation capacity: The impact of a German capacity market on Northwest Europe

Presently, Northwest European centralised electricity markets are designed as `energy-only' markets. In an energy-only market, the price received for electricity produced is set by the marginal generation unit. Potentially, the designs of these markets could leave the owners of these units with `missing money'. Among the different options available to tackle the missing money problem, capacity mechanisms have attracted most of the attention in recent policy debates in Europe. This paper presents the results based on a quantitative analysis by using a model of the European electricity market (COMPETES). Our analysis shows that unilateral introduction of a German capacity market in an integrated European electricity market can have considerable impacts on investment decisions and cross border electricity flows. Stand-alone introduction of a capacity market in Germany will likely result in higher investments in Germany at the expense of lower investments outside Germany and an increase in net exports from Germany. Neighbouring countries may have possibility to free ride on the increase in flexible capacity in Germany. The corresponding impacts are likely to be increased by the availability and expansion of interconnection capacities, hampering the level playing field within Europe. This conflicts with EU's long-term efficiency goal of market integration.