Fossil Fuel Subsidy: Korea's Excessive Capacity Payment Scheme Fuels Gas Power Expansion
Executive summary
In 2023, fossil fuels accounted for 61% of Korea's power mix. Despite the country's target to achieve carbon neutrality by 2050, the country is undergoing huge expansion of gas power plants, with 28 coal-fired power plants being converted into gas power plants under the 10th Basic Plan on Electricity Supply and Demand. This expansion is primarily driven by the power market, which incentivizes investments into new gas power plants by guaranteeing a certain level of profit above all costs through mechanisms such as Cost-Based Pool (CBP) wholesale market with settlement adjustment factor and Capacity Payment (CP).
Of the approximately KRW 78 trillion paid by Korea’s State-Owned Utility, Korea Electric Power Corporation (KEPCO) through Korea Power Exchange (KPX) to power producers in 2023, capacity payment constituted 9.5% (KRW 7.5 trillion); 43% of this amount (KRW 3.3 trillion) was allocated to gas power plants.
The following factors have made capacity payment a significant obstacle to the phase-out of aging fossil fuel power plants and a major contributor to the expansion of new gas power plants: 1) capacity payments have become excessive due to: a) absence of market competition b) the government setting generators’ economic lifespan at 30 years, c) inflation adjusted Reference Capacity Price (RCP) during the long economic lifespan; 2) Performance Capacity Factor (PCF), intended to phase out inefficient plants, has been ineffective; 3) capacity payments fail to account for GHG emissions.
Recommendations
Reform the capacity payment scheme to reduce excessive compensation for both existing and new gas power plants.
Enhance transparency regarding the data utilized in setting the reliability requirements, enabling third-party stakeholders to verify the appropriateness of the current reliability requirement.
Expand the ancillary services market (currently partially implemented in Jeju Island) and enable price competition in the power market to support the development of alternative flexible resources, such as energy storage systems (ESS) and demand response (DR)
Introduce a capacity market aligned with the 2050 carbon neutrality target.
