“We can either go for a European market or a renationalisation of energy policy. Trying to incentivise investment with volatile national schemes and have a European market at the same time is the worst option.” That’s the opinion of influential German energy expert Georg Zachmann, Research Fellow at the Brussels-based think tank the Bruegel Institute. In an interview with Energy Post, Zachmann, who has published widely about EU energy policy, offers a bold and alarming vision of the future of the European energy system. Costs, he says, will skyrocket at some point and security of supply is in danger. “We are at a cross-roads: we either need to set up a European control centre for electricity and a European emergency room for gas – or go back to national vertically integrated industries with public sector management.” 

Georg Zachmann has some bold ideas about European energy policy. In this second interview on the Energy Union ahead of the European Commission’s official launch of its own proposals on 25 February, Energy Post talks to the German national about what direction the Energy Union should take. Zachmann joined the prestigious Bruegel Institute in September 2009 after working for the German Ministry of Finance and the German Institute for Economic Research in Berlin. He is also a member of the German Advisory Group in Ukraine and the German Economic Team in Belarus and Moldova. At Bruegel, he applies his economist’s skills to energy and climate issues.

Zachmann says European energy policy is at a crossroads: the European Commission has a once in decades opportunity to kick-start the process towards a pan-European energy market design fit for a low-carbon future. He believes the Member States may have an incentive to go along with a European Energy Union – but they will only do so if the Commission comes up with a market design that they find hard to resist. If, on the other hand, they hold on to their national schemes, then, says Zachmann, the idea of a European energy market should be given up altogether. To continue wavering between European and national schemes will lead to disaster, he warns. “If I was an energy company today and I had to make investments, I would find it extremely difficult. All I could do is become too big to fail to be able to blackmail my national government to keep me alive.”

Q: Is the Energy Union really something new?

A: That’s the toughest question of all. I think nobody at this moment knows how much political capital the European Commission has and how much it will distribute to energy. If they just continue what they have been doing for the last 10 years with network codes, trying to complete the internal market, then my impression is that especially for electricity – but also for gas – the idea of the European market will fall apart.

At some stage Member States might think that all those Brussels rules to create a single market have not worked so maybe it’s better to go back to national systems.

The current electricity and gas markets in Europe are all about short term price signals, but they provide no [long-term] investment incentives. In the longer term, the wholesale electricity market will feature a price of zero and Member States will introduce all sorts of remuneration schemes for building up renewables, back-up capacity, networks, and storage. The price for final consumers will be entirely nationally driven.

Q: So business-as-usual risks driving us back to greater nationalisation?

In extremis, it might mean Member States find it difficult to keep their policy interventions in line with European legislation because that hinders some more direct interventions, while the indirect interventions that are permitted create even more distortions because you cannot directly go and build a nuclear power plant but you have to organise some sort of market for that and this market has spill-over effects and creates political uncertainty, also for the people that are building it, and then you have to pay £95 per MWh to get someone to build it and that is potentially more expensive than if you just completely renationalised the whole thing. At some stage Member States might think that all those Brussels rules to create a single market have not worked so maybe it’s better to go back to national systems.

I think the Commission has identified this as an issue and [that’s why] they are talking about a deep rehabilitation of the internal market. They want to fix all those nice, essential technical rules for the short-term – the 12 network codes – but they are also talking about a redesign. In my optimistic moments I hope that they are talking about creating a European framework in which the market also drives investments and it does not depend anymore on which side of the Rhine a power plant is built for how it is remunerated.

Q: What we’re really missing is a European framework to drive long-term investment that makes sense for the energy transition.

A: Yes. The wholesale electricity price in Germany represented about 70% of industrial consumers’ electricity costs in 2000. Today it represents less than 30%. The ETS price has dropped dramatically. So the “European part” of the market – wholesale electricity and emission allowances – has become negligible while all the other parts – network costs, capacity costs and renewables support – have skyrocketed.

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We are heading for a [decarbonised] world where we have a lot of capital invested in zero marginal cost technologies. This could work with an energy-only market [where generators are only paid when they dispatch energy] but that would mean pushing back on every Member State trying to install capacities with additional mechanisms, such as capacity markets [where generators get paid for offering backup capacity].

Q: The Commission plans to issue a new market design proposal this year. What should be in that?

A: I’m a bit agnostic on that question. We’ve seen well-functioning energy-only markets in Texas. We’ve seen well-functioning capacity mechanisms in the PJM region [in the eastern US]. Australia and New Zealand have a different system again that’s also working rather well. We have location-based prices in some regions (where each network point has its own price) and we have large market zones with single prices which are working.

We need a European control centre for the dispatch of power plants and we potentially need an emergency room at European level for the gas sector.

I think the system that you pick in the end is not so important. The question is: how do you get to a consistent system? And that for me is a political question. We have power plant parks in the different Member States that have been built up over decades in close coordination with the regulations in those countries. In France, for example, low regulated residential tariffs lead to a high share of electric space and service water heating which brought about a convenient baseload for using up a substantial fraction of the nuclear baseload capacities. Feedback loops between power plant parks and legislation are observable in each and every Member State. Harmonising these is necessary if you want to get to a consistent European market.

We need a politically legitimate European discussion about market design. The risk I see with the regional approach [proposed by the Commission] is that you lock in different regional development patterns and you don’t get the big benefits of bringing Atlantic wind power together with North Sea wind power, for example.

Q: The Commission seems to be putting a lot of emphasis on the regional approach, however. Do you see any merit to it at all?

A: I think a big market design reform will only happen once every two or three decades. If we now harmonise the northwest European market, I would not expect us to harmonise it with the Nordic market for example any time soon. Because there are so many rules to be changed and it is such a complex political discussion. I see that a regional approach is easier [but] I would strongly urge the Commission to think whether it’s not possible to go for a more European market design.

I see the Commission take a lot of pride in the Pentalateral Energy Forum. But most people say this was the region’s own, not the Commission’s, initiative. Maybe it’s an easy way out: you let a thousand flowers bloom, you let Member States arrange their regional deals and you stop doing a lot of European energy policy because it’s so difficult. In the end you claim that Europe is about regional integration. But from the Commission, this would be an unusually hands-off approach.

In terms of market design I’m also a bit worried about security of supply. What’s the point in having regional cooperation on security of supply in Central and Eastern Europe? What can the Poles and Slovakians and Hungarians do together? They need the Germans and the Spaniards and the French to give them the gas that the Russians don’t deliver.

Q: How much appetite is there though for a truly European approach to energy market design?

A: My belief is that the cost of the electricity sector will skyrocket at some moment. France has to rebuild its nuclear fleet, the UK also has to replace much of its existing power plant fleet and Germany wants to carry through its Energiewende.

We have no European electricity market model that everyone can contribute to; we have the Primes model that nobody understands and nobody has access to.

I think we’re at a crossroads. We can either go for a European market or a renationalisation: Member States go back to the Electricity Board [set up] of Great Britain of the 1980s, with a vertically integrated industry and public sector management, and try to do it less inefficiently than before. Trying to incentivise investment with volatile national schemes and have a European market [at the same time] is I think the most expensive option.

Q: Why would Member States go for the European option, rather than revert to a national approach?

A: In my pessimistic moments, I expect a spiralling down with more and more [national] policy interventions into the European market for another 10 years. On the other hand, as I said, France, the UK and Germany have some issues they might want to get rid of politically. If France has to pay for its nuclear fleet rehabilitation out of its own pocket, it will be extremely expensive for the Treasury. In Germany, there is a discussion on electricity prices and at some stage we’ll have to see whether the Energiewende can go on, especially if some neighbouring countries no longer accept to be its airbag. Maybe all Member States have some incentive to shift the problem up one level.

Q: What will tip the scale towards a more or less ambitious Energy Union?

A: I think it will be mainly driven by national discussions but also by the effort the Commission puts in: coming up with a process for a new market design that Member States find it very difficult to abstain from. More like a Schengen approach: if you’re not in, you’re not in, but this is the core, the system we want to develop at European level. If the Commission only comes up with small changes at the fringes and tries to push back on the worst exaggerations of capacity mechanisms for example, it will be like pushing back on regulated electricity prices in France, which hasn’t worked for 20 years.

Q: You’ve said we need a 4^thenergy market liberalisation package. What should be in it?

A: There need to be institutional arrangements that put some powers into the centre to enable either ACER or the Commission to take decisions on how the market is run. We need a European control centre for the dispatch of power plants and we potentially need an emergency room at European level for the gas sector. In addition, I would really like to see the decision on market design go through the ordinary legislative procedure: the European Parliament can give it political legitimacy.

The point of a market is to drive innovation. If you start by saying that’s the fuel mix I want then just go and build it.

I would like to see the ENTSO’s [European transmission system operators in electricity and gas] more independent from the [national] TSOs. Network planning should be more of a societal exercise. I think a lot of public opposition stems from the fact that they are not really included in the process and the process is so opaque. Currently, the TSO decides what might be good for them, gets consultancy studies saying it’s good for everybody and it’s difficult for anyone to evaluate.

It’s important to strengthen the modelling capacities of the Commission. Like [Jean-Arnold] Vinois said, we need a European energy [and climate] information agency. We have no European electricity market model that everyone can contribute to; we have the Primes model that nobody understands and nobody has access to. Opening up the discussion might make it more difficult for Member States to stay outside and block the whole thing. I think energy policy making in Europe is done on such a low level of debate that it’s not really fit for purpose. We should invest some more money into the brain of policy making.

Q: Do we need a change in the European Treaty, which gives Member States the right to determine their own fuel mix?

A: I think Treaty change is not necessary. I’m not a lawyer but in my opinion there is room for interpretation: if Member States are willing to give certain powers to the centre it does not necessarily require a change to the Treaty.

Let’s interpret the [right for every Member State to decide its own] fuel mix provision as a kind of negative prerogative: a Member State can decide what they don’t want. If we leave the rest to the market, it could still function pretty well. But as soon as we allow Member States to positively define their fuel mix, it’s not going to work. The point of a market is to drive innovation. If you start by saying that’s the fuel mix I want then just go and build it.

Q: How does the Energy Union fit with the 2030 climate and energy package?

A: I think it’s very difficult to disentangle the two. In my opinion the 2030 targets are not very logical, they’re just an extrapolation of the 2020 targets and there’s no clear narrative behind them. The non-binding targets for renewables and energy efficiency are already a sign of renationalisation. The European greenhouse gas reduction target is perhaps the right one to emphasise, but what I would like to discuss more is how the Energy Union will deliver on it.

Q: What do you see finally driving long-term investment and innovation? The EU ETS? Renewables and efficiency policy? A new energy market design?

A: It would be great if the EU ETS would play a strong role because it will lift all low-carbon boats at the same time. In addition we need more R&D subsides. I think current spend on green R&D is very limited compared to the challenge we are facing.

The energy companies have been passive and very slow in pushing for a European market. They’ve not come up with a unified view of what they’d like to have.

We should also rethink the way we support renewables. Support schemes made it too easy to make a lot of money without doing a lot of innovation. Yet innovation is making these technologies so cheap they can compete with Chinese coal and I think that is what is deciding the [climate] game in the end: keeping Chinese coal in the ground.

Q: What is the energy sector supposed to make of all this?

A: If I was a company today and I had to make investments, I would find it extremely difficult. There is no framework that is sufficiently long term to give an indication of my future cash flows from investments. Everything seems to be in flux. All I could do is become too big to fail – as the banks did – to be able to blackmail my national government to keep me alive. That’s not a very good situation. The energy companies have been passive and very slow in pushing for a European market. They’ve not come up with a unified view of what they’d like to have and what they’re willing to give up, to get there. Like I said, we’re at a crossroads.

Editor’s Note

This is the third article (and second interview) in a series on the Energy Union published by Energy Post in the run-up to the Communication on the Energy Union from the European Commission which will be published on 25 February. See also: 

Karel Beckman, The Energy Union: It’s Now or Never for a European Energy Policy (18 February)

Sonja van Renssen, A “J’Accuse” from an ex-EU official: only a real Energy Union can save the EU energy market (Interview with Jean-Arnold Vinois, 3 February)

And see Sonja van Renssen, The Energy Union: “a holistic approach to the energy transition” (8 February) for an overview of what is currently known about the Commission’s plans.