*** REGISTER NOW *** for our online panel discussion on Friday 24th March 09:30-10:45 CET, “Electricity Market Design: how can reforms accelerate the transition and help cut energy prices?” Our panellists are Catharina Sikow-Magny, Director, DG ENER; Wanda Buk, Vice-President for Regulatory Affairs, PGE; Leonardo Meeus, Director of the Florence School of Regulation; Jérôme Le Page, Director for European Electricity Markets, EFET; Michaela Holl, Project Lead for the EU Green Deal, Agora Energiewende. Here, Simon Göss summarises the issues. He looks at how the high energy prices triggered the calls for reform, the intense debates over whether reform, transition or a complete overhaul are required, and what the Commission is focussing on. Ultimately, the challenge is how to integrate the longer-term instruments into the short-term market so that acceptable prices are delivered for all. [Promoted by PGE]
Electricity market design reform in times of crises
With natural gas and other commodities at record price levels during 2022, causing spikes in the wholesale electricity market, the working principles of the EU energy market have been widely discussed. The core topics of the reform revolve around how to make electricity bills less dependent on short-term fossil fuel prices, how to drive renewable investments and how to improve conditions for flexibility.
High electricity prices call for reforms
The EU electricity market is in need of either a small reform, a transition or a complete overhaul, depending on who you ask. In order to substantiate options and allow industry, associations and the public at large participate, the EU commission launched the public consultation as part of the electricity market reform on 23rd January 2023. The consultation runs until 13th of February and the EU Commission intends to propose a reform by the end of March. All of this begs the question: what brought us here in the first place? And why is the electricity market suddenly under such scrutiny?
Two main reasons have to be distinguished in this discussion. Firstly, most of the current suggestions for reform are a reaction to the ongoing energy supply crises caused by a shortage of gas deliveries from Russia which feed back into the electricity market. Secondly, policymakers and some players in the energy sector regarded the existing design of the European or their national electricity markets not fit for incentivising firm power generation capacity in an electricity system increasingly dominated by fluctuating renewables.
Another important factor for consideration is that the grid constraints are often a serious challenge for the development of renewables. Such issues also emphasise the importance of the investments in the distribution infrastructure and the form of financing of those investments (e.g. alternatives for distribution tariffs) needs to be addressed by the new energy market design reform.
The calls for electricity market reform got increasingly louder during 2022, as the energy supply crises led to unprecedented gas and electricity prices on the market (Figure 1). So, the energy crises due to the Russian war in Ukraine can be seen as the trigger to interventions previously not seen as necessary.
Reform, transition or overhaul?
Various ideas and proposals backed by different countries or blocks of countries have been floating around in the EU already since 2021. Without going too much into details, some of the more controversial proposals would fundamentally alter the processes, functions and price-forming mechanisms of the EU electricity markets.
In the so-called Greek model, the wholesale electricity market would be split into two segments. The low variable cost segment of wind, solar, nuclear, hydro would be remunerated by contracts for differences (CfDs) based on their full costs. The other, high marginal cost generation technologies, such as coal or gas would still be dispatched based on the existing marginal pricing in the day-ahead market. The end consumers would then pay an average of the two segments.
But some member states point out that the short-term price signals are not adequate to support long-term decarbonisation. The recent reform proposals by Spain and France aim to change this by measures like long-term capacity mechanisms and CfDs (Spain) or broad application of CfDs and redistribution of the revenues from such contracts (France). Such proposals emphasise the necessity of stable support schemes in the longer time horizon.
Many debates and analyses on the effects of different proposals have been published and a good overview can be found here. Any proposal that aims to curb prices for end users comes with pros and cons in terms of ease of implementation, market efficiencies, unintended consequences (especially in times of crises) and distributional considerations.
What is the Commission focusing on?
The Commission’s task will be to mediate between the diverging interests of different generators, national states with varying generation mixes, end users and industry as well as considering the long-term targets of the energy transition towards renewables. With this in mind, the task is daunting and the reform will focus on the following topics (also compare Figure 2):
- Making electricity bills more independent from short-term costs of fossil fuels
- Driving renewables investments
- Improving conditions for flexibility alternatives to gas
- Better consumer empowerment
- Stronger protection against market manipulation
Not all needs to be made new and the Commission recognises that the current design of the electricity market has been beneficial to Europa in many ways: from creating a single market across different countries, to ensuring security of supply, interconnectivity and integrating fluctuating renewable generation.
Thus, a focus will be on which instruments can incentivise the use of long-term contracts to reduce the exposure of electricity users to short-term fossil fuel price hikes. Power Purchase Agreements (PPAs) and CfDs are seen as potential ways to both finance renewable capacity and to transfer the low-cost generation of these renewables to end consumers. While there is no silver bullet, solutions like PPAs in the form of two-way CfDs might offer more stability and price predictability, benefitting both consumers and power companies. Such a solution would also address the issue of windfall profits, making future ad hoc interventions unnecessary.
Many details of how these two instruments can and should be used, which role the nation states should have in financially supporting generators via CfDs and how to integrate those longer-term instruments into the short-term market needed for dispatching decisions are still open. The input from the public consultation will certainly help in making this decision.
Our online panel discussion on Friday 24th March will discuss all the important questions…
- What are the real costs of intervention measures?
- How long can and should extraordinary crises measures be in place?
- How to achieve acceptable prices for end consumers while providing enough incentives for firm generation capacity and flexibility as well as for ramping up renewable generation?
- How to remove barriers to entry for new zero-emission capacity?
- How to protect vulnerable consumers while financing large-scale and capital consuming investments at the same time?
- How to design the right CfD model to ensure that new investments will come in time to deliver the Green Deal?
- How to ensure that the existing electricity generation will stay on the market?