Cross-border solidarity versus national capacity markets : risk of inadequate capacity procurement

In Europe, capacity markets are currently designed and operated at the national level, which can give rise to non-cooperative behavior. Member States may strategically influence national capacity procurement to maximize national welfare rather than cooperating towards the regionally optimal procurement. Using a stylized analytical model of two interconnected capacity markets, this paper evaluates the risk of such non-cooperative behavior. We differentiate between three options for the allocation of capacity markets’ costs and benefits: local, reservation, and sharing. Under the current EU framework, the benefits of capacity markets are shared regionally, as curtailment sharing applies in the day-ahead market clearing algorithm in cases of simultaneous scarcity, while capacity procurement costs are borne nationally. Sharing benefits but not costs creates incentives for freeriding, potentially leading to regional under-procurement of capacity. Moreover, the absence of a direct link between procured capacity and curtailment allocation weakens incentives for implementing explicit cross-border participation in capacity markets. We identify three possible remedies: (i) maintaining the existing framework with ad-hoc cross-border compensations, (ii) modifying curtailment rules so that cross-border flows reflect national capacity procurement rather than solidarity, or (iii) sharing exante capacity costs through a regional capacity market. As the first two options appear more difficult to implement and unsatisfactory in the long term, we argue that a regional or European capacity procurement approach is increasingly necessary, given rising interconnectivity and the expanding scope of capacity markets in Europe.