The capacity market and the energy market are two different market models designed to ensure the supply of electricity. While the energy market compensates only for the energy actually delivered, the capacity market provides additional compensation for the provision of capacity. The discussion surrounding both models is closely linked to issues of supply security, the energy transition, and the increasing volatility of renewable energy sources.
Definition of terms
The energy market is a market model in which payment is made exclusively for the electrical energy that is actually generated and supplied. It is therefore also referred to as an “energy-only” market.
The capacity market supplements the energy market by providing compensation for the mere provision of generation capacity. Power plants or flexible facilities receive payments for being available when needed, regardless of whether they actually supply electricity.
Energy Market (Energy-Only Market)
In the energy market, revenue is generated exclusively through the sale of electricity on exchanges or through bilateral contracts. Key features include:
- Pricing Based on Supply and Demand
- Order of deployment according to the merit-order principle
- Revenue is generated only when electricity is actually delivered
In Germany, the energy market forms the foundation of the electricity system. Exchanges—such as those for day-ahead and intraday trading (e.g., EPEX SPOT)—are central trading venues in this model.
Capacity Market
In the capacity market, plant operators receive a payment for providing capacity in addition to their energy compensation. The goal is to ensure that sufficient controllable capacity is available at all times to offset peak loads or generation outages.
Typical characteristics of a capacity market include:
- Rewarding a Willingness to Perform
- Long-Term Planning Certainty for Plant Operators
- Politically and Regulatorily Driven Design
In some countries, capacity markets are used as a supplement to or alternative for the energy market.
There is currently no comprehensive capacity market in the German electricity system. Germany continues to rely on the “energy-only” market as its central market design. However, to ensure security of supply, this model is supplemented by additional instruments, in particular the capacity reserve and the strategic reserve. These mechanisms ensure that generation capacity is maintained for exceptional situations without replacing the fundamental market mechanism of the energy market.
Differences Between the Capacity Market and the Energy Market
The key differences can be summarized as follows:
- The energy market pays for energy; the capacity market pays for capacity
- In the energy market, revenue is generated only through electricity generation
- In the capacity market, revenue is generated even without actual power generation
- The energy market relies more heavily on price signals, while the capacity market relies on regulatory safeguards
Both models aim to ensure security of supply, but use different mechanisms.
The Role of Renewable Energy
The growing share of renewable energy is changing the demands placed on the electricity market. The generation of renewable energy depends on weather conditions, which is why additional flexibility and reliable power are becoming increasingly important
This leads to:
- greater volatility in electricity prices
- the growing importance of flexible, controllable capacity
- Discussions on the Need for Additional Capacity Mechanisms
In this context, the capacity market is often viewed as a potential tool for securing the system.
Impact on Electricity Prices and Security of Supply
In the energy market, high prices during periods of scarcity can provide incentives to invest in new capacity. Critics, however, see a risk that these price signals may not be sufficient to ensure long-term security of supply.
Capacity markets are intended to reduce this risk, but they may:
- incur additional costs
- Step up market interventions
- Creating perverse incentives if they are not designed with precision
The structure of the market design is therefore crucial.
Relevance for companies
For companies, the distinction between the capacity market and the energy market is important because:
- Influenced by Electricity Prices and Price Volatility
- Shapes investment decisions in the energy system
- determines the economic value of flexibility
Companies with generation facilities, storage facilities, or controllable loads are particularly affected, as their facilities can potentially play different roles in both market models.
Relationship to Flexibility and Storage
Flexibility plays an important role in both market models. Energy storage systems, flexible consumers, and controllable generation facilities can:
- Taking Advantage of Price Signals in the Energy Market
- Supporting Security of Supply
- Provide capacity on short notice
Therefore, there are close connections to:
- Flexibility Markets
- Grid-supportive storage control
- Load shifting through storage
- Demand Side Management (DSM)
- Control energy
Distinction from related terms
Not to be confused with:
- Control Energy: Short-Term Compensation for Frequency Deviations
- Secondary Control Power (SRL) and Tertiary Control Power (TRL): Submarkets for Control Energy
- Grid Fees and Surcharges: Regulated Components of the Electricity Price
- Congestion Management in the Electric Power Grid: Grid-Side Measures to Prevent Overload
Summary
The capacity market and the energy market are two different approaches to organizing the electricity supply. While the energy market relies on price signals and compensation for energy actually delivered , the capacity market supplements this model with payments for the provision of capacity. With the growing share of renewable energy, the discussion about ensuring long-term security of supply is gaining importance. For companies, plant operators, and flexible consumers, the interplay between these two models is relevant, as it significantly influences electricity prices, investment incentives, and the economic value of flexibility.
