France was asked to change its original plans to maintain competition in the sector, the Commission said.
Under the mechanism electricity capacity providers such as power plants or demand side operators and electricity suppliers will trade capacity obligations, to ensure capacity is available when demand for electricity is particularly high. When a provider offers access to power it will receive certificates, which suppliers will then buy to gain access to power during peak periods of demand. The certificates can be traded between providers and suppliers, or through public auctions, the Commission said.
The Commission had opened an investigation into the measure in November 2015 over concerns that the planned capacity mechanism might favour certain companies over their competitors and hinder the entry of new players.
In response to these concerns, France agreed to modify the mechanism by offering seven-year certificates for new providers, rather than the standard one-year certificates, if these providers can be shown to be more competitive than existing providers.
A public auction of certificates will be held in four years time, to give new projects time to develop, the Commission said.
The mechanism will also be opened to capacity providers in neighbouring EU member states.
In addition, France will introduce measures to prevent market manipulation. Providers' capacity declarations will be compared to historical benchmarks to prevent them from under-certifying their capacity to artificially drive up capacity prices. Large capacity providers will have to offer a specified minimum amount of certificates during the organised auctions to increase liquidity in the capacity market, the Commission said.
Commissioner Margrethe Vestager, in charge of competition policy said: "The French capacity mechanism will be open to all capacity providers, including those located across the border, and allow new players to enter the market. This ensures that the measure is cost-effective and competitive. Today's approval ensures that electricity prices are kept in check for consumers. We have worked constructively with the French authorities to bring the planned French mechanism into line with EU state aid rules."
State aid expert Caroline Janssens of Pinsent Masons, the law firm behind Out-Law.com said: "This decision is issued in the context of the European Commission's state aid sector inquiry into capacity mechanisms that it launched in April 2015 and for which a final report is expected for the end of this year. The Commission looked into national measures used by member states to ensure that domestic electricity demands are met at all times to avoid black-outs, in particular in peak seasons such as in winter. Increasingly member states are introducing such mechanisms to incentivise investments in power generation, to incentivise existing power plants to continue to operate or to encourage demand reduction when there are concerns that demand may not match supply."
"The end purpose of all these mechanisms is to ensure continuity of electricity supply. The Commission was particularly interested in understanding these mechanisms and in assessing whether or not they had the potential to distort competition by giving undue advantage to some operators. In its preliminary report, issued in April this year, the Commission said that capacity mechanisms may be allowed under state aid rules. However, the Commission also said that some capacity mechanisms may have a negative impact on competition and must not be used as a "quick fix", without considering long term implications," Janssens said.
"The Commission further said that EU countries should be encouraged to look at all options for dealing with capacity issues, and any capacity mechanisms used should be open to all providers to improve competition, which the amended French measures do. The Commission also encouraged a common EU approach to security of electricity supply. Companies that have benefited from such measures should carefully review their records and ensure they comply with state aid rules," she said.