Capacity mechanisms have become one of the most contentious instruments in European electricity market design, and nowhere is that tension more visible than in South-Eastern Europe. In theory, capacity mechanisms exist to ensure security of supply by remunerating availability rather than energy production. In practice, in SEE they sit at the intersection of decarbonisation, legacy asset protection, fiscal constraints, and market integration. Whether they function as rational system insurance or as structural market distortion depends less on their existence than on how they are designed and deployed.
The underlying reason capacity mechanisms have returned to the policy agenda is straightforward. Energy-only markets struggle to deliver sufficient revenue certainty for assets that are critical but rarely dispatched. As South-Eastern Europe transitions toward higher shares of variable renewables, the number of hours during which dispatchable plants operate continues to fall. Yet the system’s dependence on those plants during stress periods has not diminished. On the contrary, it has increased.
Quantitatively, this contradiction is clear. In several SEE systems, dispatchable thermal assets now operate at annual load factors below 25–35 percent, compared to 60–80 percent historically. Despite this, these same assets are required to be available during extreme hours when prices spike above €300–500/MWh, and occasionally above €1,000/MWh. The system depends on them precisely when energy-only revenues are least predictable.
Without capacity remuneration, the rational economic response is underinvestment or premature exit. Yet uncontrolled exit would expose systems to adequacy risks and extreme volatility. Capacity mechanisms emerge as a response to this market failure. The question is not whether they are needed, but whether they can be designed to support flexibility rather than entrench inefficiency.
South-Eastern Europe approaches capacity mechanisms from a structurally different starting point than Western Europe. Many systems still rely heavily on lignite and coal for adequacy. These assets are politically sensitive and socially embedded, often tied to employment and regional development. Capacity mechanisms risk becoming instruments to prolong their operation rather than facilitate transition. This risk is not theoretical. In systems where capacity payments are awarded based on installed capacity alone, without strong performance or emissions criteria, legacy assets can crowd out investment in cleaner and more flexible alternatives.
At the same time, the absence of any capacity framework produces its own distortions. State-owned utilities are often forced to carry loss-making plants on their balance sheets for security reasons, effectively providing implicit capacity support without transparency or market discipline. This undermines financial sustainability and obscures the true cost of security of supply.
From a system economics perspective, capacity mechanisms should be understood as insurance contracts. Their purpose is to ensure availability during scarcity events, not to subsidise energy production. In this framing, the critical design parameters are performance obligations, flexibility requirements, and cost containment.
The evidence from recent stress events underscores the value of such insurance. During summer and winter tight periods in 2024–2026, a limited number of hours accounted for a disproportionate share of system risk. In several SEE markets, fewer than 100 hours per year determined adequacy margins and price spikes. Capacity mechanisms that reward assets capable of delivering during those hours can significantly reduce volatility and emergency intervention costs.
However, poorly designed mechanisms can do the opposite. If capacity payments are too generous, they suppress scarcity pricing signals, discourage demand response, and slow investment in storage and flexibility. If they are technology-neutral without flexibility weighting, they favour inflexible baseload assets over fast-responding resources that the system increasingly needs.
Another structural issue is regional fragmentation. Capacity mechanisms are typically national, yet electricity systems in SEE are increasingly regional. National adequacy assessments fail to account for cross-border support and shared risk. This can lead to over-procurement of capacity in some countries and under-recognition of regional flexibility in others. In an integrated market, uncoordinated capacity mechanisms distort cross-border flows and investment signals.
Quantitatively, the cost implications are material. Even modest capacity payments of €40–80 per kW per year translate into hundreds of millions of euros annually at the system level. These costs are ultimately borne by consumers or taxpayers. Without coordination, the region risks paying multiple times for the same insurance.
The strategic challenge for SEE is therefore twofold. First, capacity mechanisms must be redesigned to reward flexibility, availability, and emissions performance rather than mere existence. Second, they must be aligned regionally to avoid fragmentation and inefficiency.
A flexibility-oriented mechanism would prioritise fast ramping, low minimum stable output, and reliability under stress. Gas plants, storage, hydro reservoirs, and demand response would compete on a level playing field. High-emission assets could still participate, but only if they meet strict availability and performance criteria, with declining eligibility over time.
Equally important is integration with market coupling and balancing markets. Capacity mechanisms should complement, not replace, scarcity pricing. They should smooth investment incentives without suppressing short-term signals. This balance is delicate but achievable.
In South-Eastern Europe, the political temptation will be to use capacity mechanisms as tools of delay. That path would lock in inefficiency and postpone necessary system adaptation. The alternative is to treat capacity mechanisms as transitional instruments, explicitly designed to fade as storage, demand response, and cross-border integration mature.
The difference between insurance and distortion lies entirely in governance. If capacity mechanisms are transparent, performance-based, and regionally coherent, they can stabilise SEE electricity systems during transition. If they are opaque, protectionist, and static, they will become structural barriers to decarbonisation and market integration.
By virtu.energy
