Market reform options for a reliable, cost-efficient and decarbonised Italian power system
In its recent draft National Energy and Climate Plan, Italy set ambitious targets for increasing the share of variable renewable energy and committed to closing all coal plants by 2025. These developments, coupled with concerns about the economic viability of power plants and the ability to “keep the lights on,” resulted in the government introducing a capacity market.
Christos Kolokathis and Michael Hogan offer a review of the resource adequacy outlook for Italy and the design of the capacity market, and map out a pathway for achieving a reliable, cost‑efficient and decarbonised Italian power system.
Our study finds that a capacity market in Italy is unwarranted. It is questionable whether Italy truly has a resource adequacy problem. We expect the capacity market to lead to overprocurement, carbon lock-in and excessive costs for consumers.
The implementation of the capacity market appears to be driven by undue emphasis on highly improbable outcomes that, for example, ignore the existence of a market. In addition, the Europe‑wide resource adequacy assessment, based on which the risks for Italy are assessed, is generally conservative. These considerations effectively imply that Italian consumers are willing to spend hundreds of thousands of euros per megawatt hour to address highly unlikely outcomes. Yet alternatives with significantly lower costs are available to secure supply.
In order to achieve reliability at least cost, an important first step would be that the Italian authorities undertake a thorough and balanced analysis of the risks to the security of electricity supply and determine whether market intervention in the form of a capacity remuneration mechanism is necessary. This process should be fully transparent and subject to public scrutiny.
In addition, we recommend that the relevant authorities adjust the design of the capacity market — if there is to be one — to ensure it doesn’t undermine the operation of the energy market. There are clear indications that the capacity market supports the development of fossil-fuel generators while stymieing the development of cleaner and more cost-effective resources, such as demand response and storage. Policymakers should put safeguards in place to eliminate the risk of resource overprocurement stemming from the system operator’s intrinsic bias to procure more than is necessary or economically justified.
Finally, we encourage the Italian authorities to prioritise wholesale market reforms and other measures to achieve the aforementioned goals, such as implementing administrative shortage pricing in the balancing market and empowering consumers to actively participate in the market through demand response. If there are legitimate concerns about the risks to security of supply while the market is transitioning, the authorities could consider implementing a strategic reserve until those reforms have taken full effect.