Effectively Utilising Energy Storage in Capacity Markets Will Increase Energy Security in Europe

The decarbonization of the European energy system can only succeed if we decarbonize Europe’s entire generation fleet. As renewable generators increasingly push coal and gas plants out of the wholesale power market, capacity markets across the continent remain a refuge for fossil generators. To achieve the deep decarbonization of the European energy system, capacity markets need to decarbonize. Energy storage is set to take a key role in this shift.  

Battery-based energy storage already plays a critical role in supporting energy security across Europe. Using storage to provide fast-responding frequency regulation services and reinforcing grid infrastructure are critical for system stability, but the role of capacity markets should not be ignored.  

Looking back, when fossil generators produced the majority of electricity, dispatchable capacity – generation assets that can be switched on and off independently of weather conditions – were present in large quantities in the power system. But this has changed. Today, increasing volumes of low-cost renewable energy are pushing fossil generators out of the market. This means the share of dispatchable capacity is shrinking and can no longer be taken for granted. As a result, capacity markets, which pay generation assets for being available when needed, have become a common element of electricity market design in many European markets.

Great Britain was one of Europe’s first markets to introduce a capacity market. Many people may have forgotten the capacity market’s role in kicking off investments in the battery energy storage market in Great Britain alongside the reform of ancillary services products, however it is accelerating investment in storage still today.  

Great Britain does not stand alone. More than 5 GW of battery energy storage assets have received capacity market contracts across Europe over the last three years. Today, capacity markets exist in several European Union (EU) member states and Great Britain. Energy storage is allowed to participate in these markets, and battery storage is regularly awarded contracts in capacity market auctions. In some countries, such as Italy in 2022 or Poland in 2022 and 2023, capacity markets were key for unlocking GW-scale battery storage markets. In those markets, energy storage is allowed to compete on a level playing field with conventional generation, such as gas peakers. The contracts are awarded based on their cost-effectiveness in getting the job done. But this is not the case everywhere.

Unfortunately, battery storage is still underutilized in many capacity markets and across broader energy security considerations. Many capacity markets remain primarily designed and remunerated with gas-based generation in mind, and storage must somehow fit in. As two of Europe’s largest power markets — Germany and Spain — are now considering introducing capacity markets, we must design them for the future, not for the past.  

The future role of non-fossil flexibility in capacity markets  

Capacity markets are often described as lifelines to struggling fossil power plants, which are being pushed out of the market. While energy security requires having dispatchable capability on the system, Europe cannot decarbonize if often highly polluting fossil power plants are kept online. Utilising lower-emission solutions in capacity markets is a necessary next step on Europe’s decarbonization pathway.

Current policy proposals go in the right direction. Still, EU member states must follow through and seriously consider capacity market reform or draw the proper lessons as they implement their mechanisms. The latest electricity market reform puts a special spotlight on the role of energy storage in capacity market mechanisms.  

Capacity Market Reform Proposals

EU electricity market design reform will require member states to assess their flexibility needs and establish energy storage targets. The reform also asks member states to strengthen the role of non-fossil flexibility in capacity mechanisms. But how does this work?  

All stakeholders should provide clearer guidance on how to promote the participation of non-fossil flexibility, such as energy storage, in capacity markets. Specifically, two reform elements that can be implemented in national capacity market designs would improve the role of capacity markets as part of a changing energy system. These could, and maybe should, be part of an upcoming EU storage strategy and capacity market design in member states:

1. Decreasing carbon caps as part of prequalification requirements would, over time, reduce the number of high-emitting technologies that are awarded contracts. For example, the current carbon cap of 550g/kW could be reduced over the next few years, allowing assets in capacity markets to become more climate-friendly.  
2. Introducing a carbon revenue scalar would create a market-based, technology-neutral incentive mechanism to reduce emissions. A carbon revenue scalar would pay assets with low emissions relatively higher revenues for providing capacity market services, while assets with higher emissions would see lower payments for providing the same service. Similar technology-agnostic scalars have been used in European power markets for years.  

The key to both proposals is technology neutrality. Market design should avoid picking specific technology winners but define requirements that should be met. Both proposals pass this test and would allow other non-fossil technologies, such as demand response, carbon capture and storage, or hydrogen-powered gas peakers, to compete on equal terms.  

Meeting Europe’s energy security and emission reduction targets should be non-negotiable. Battery energy storage is already playing a critical role across European capacity markets. Market reform and potential introductions of new capacity markets create an opportunity to rewrite the energy security narrative. In this process, it is critical to avoid technology lock-in of high-emitting power generation technologies, which would erode our ability to meet Europe’s emission reduction targets.

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