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In a previous analysis of Germany’s renewable energy opportunities, we noted ongoing discussions around a potential capacity market mechanism by 2028. The industry debate around this is intensifying, revealing significant disagreements between stakeholders who feel that the current system works and those who fear it may not work for much longer.
On the one hand, Germany’s current energy-only market (EOM) functions effectively: generators are paid exclusively for the electricity they actually deliver, and this market-based mechanism has successfully driven massive investment in renewable energy and battery storage (BESS).
On the other hand, powerful voices, including one of the country’s Transmission System Operators (TSOs), TransnetBW, are calling for the introduction of a capacity market (CM). This proposed system would pay providers not for the power they produce, but for the mere promise of capacity – the guaranteed availability to generate electricity during future periods of high demand or system stress, such as the dark, still periods of winter. Proponents argue it is essential to ensure reliability as coal and nuclear are phased out, while opponents see it as a dangerous distortion of a thriving market that risks locking in fossil fuels and stifling innovation. This article looks at both sides of the argument, the immediate regulatory hurdle of the BKZ grid fee, and what these dynamics could mean for project financing.
Who wants a capacity market, and why?
Germany’s energy transition (Energiewende) has positioned the country as a leader in renewable energy adoption, with renewables accounting for between 50% and 67% of its electricity mix. However, this rapid expansion of variable renewable sources like solar and wind creates challenges for grid stability and reliability. Generation fluctuates based on weather conditions, leading to potential supply gaps during periods of low wind and sunlight known as Dunkelflaute (“dark doldrums”).
To address this, Germany is considering introducing a capacity market mechanism by 2028 designed to ensure reliable electricity supply. The proposal involves consultation around various options for the design of the CM and to introduce it as part of a combined (centralised and decentralised) model that incentivises flexible consumer and storage facilities alongside power plants. It’s supported by the German Federal Ministry for Economic Affairs and Climate Protection (BMWK) and involves a technology-neutral approach to guarantee system adequacy and stable investment, including renewables, storage, and flexible loads.
Another CM advantage is its ability to unlock financing for new projects. By providing a stable, long-term revenue stream for being available, capacity payments would de-risk investments, particularly for capital-intensive projects. Guaranteed income reduces reliance on volatile merchant revenues from energy trading and ancillary services, making banks more comfortable providing debt financing. Project bankability like this addresses a key concern for developers and financial institutions.
Proponents also argue that a centrally organised capacity auction would facilitate a more strategic and predictable build-out of necessary capacity, instead of piecemeal, reactive development driven by short-term market signals. Planned expansion like this ensures that the right types of resources are developed in the right locations, creating resilience and reliability. In short, those in favour of a CM think it will solve:
- Volatility of energy prices
- Barriers to investment
- Risk of undersupply
- The need for additional measures to ensure network stability
But why fix a system that isn’t broken?
Developers who are not in favour of a CM point to the fact that the current system is working effectively, delivering substantial investment in BESS and other flexibility solutions without government intervention. Worries about a CM revolve around these concerns:
- The additional costs of securing capacities are usually passed on to electricity customers.
- CMs can create excess capacity when too many plants are built just to receive capacity payments.
- CMs can distort competition by favouring certain technologies or existing, larger players who have easier access to capital.
- CMs can support the continued operation of environmentally damaging fossil power plants or delay their closure.
- They may distort prices in the EOM and undermine investments made on the basis of the EOM.
EOM proponents hold that introducing a capacity mechanism would distort the very price signals that drive innovation and efficient operation in the existing market. Analysis shows that Germany’s current market design has successfully attracted significant investment in flexibility resources without capacity payments.
Then there is the gas plant problem, with substantial risk that a technology-neutral CM auction would primarily subsidise the construction of new gas-fired power plants, potentially locking in fossil fuel infrastructure for decades. This would directly contradict Germany’s decarbonisation goals and climate commitments. Critics point to experiences in other European markets where capacity mechanisms have disproportionately benefited fossil fuel assets.
Then there is the question of whether BESS even needs CM support. Battery storage is already proving its commercial viability in Germany’s frequency regulation and energy arbitrage markets. CM mechanisms are traditionally used to support technologies that aren’t economically viable on their own – but revenue stack analyses show that BESS projects are achieving attractive returns through existing market mechanisms. And they are being built and financed based on their ability to compete and generate revenue in Germany’s existing EOM, operating without direct taxpayer subsidies. The introduction of a capacity market would force them to compete against government-backed assets – such as already-mentioned new gas power plants – that receive guaranteed payments through the CM. This creates an uneven playing field, where the true cost of securing capacity is passed through to all electricity consumers via their bills, potentially distorting the market that BESS projects have so far thrived in without public financial support.
The BKZ Wildcard
The Baukostenzuschuss (BKZ) is a significant upfront grid connection fee charged by distribution (DSO) and TSO system operators, directly adding to a project’s capital expenditure. This creates immediate financial strain and uncertainty. A lost court battle over its legality for storage projects, coupled with cost variations between different grid operators, makes projects more expensive and financial planning and site selection more complex.
In the EOM, the high, unpredictable BKZ erodes project returns, making it harder for merchant projects to secure financing based on volatile revenue forecasts. For a future CM, these fees directly undermine the mechanism’s goal of ensuring new capacity. If the BKZ remains a barrier, it could prevent the very new, flexible assets the CM is meant to incentivise from being built, rendering the policy less effective before it even starts.
Lessons from elsewhere
The UK’s and Poland’s experience with CMs offers insight. The UK’s model demonstrates that a well-designed mechanism can integrate batteries and demand response, avoiding a pure lock-in for large gas plants. Conversely, Poland’s example serves as a cautionary tale of how these markets can inadvertently prolong the life of polluting fossil assets if climate goals are not hardwired into their design.
