It is still far from perfect and has been painfully slow in taking shape, but an EU-wide power market has now emerged. Jean-Michel Glachant, Director of the European University Institute’s Florence School of Regulation where he holds the Loyola de Palacio Chair, nevertheless warns that renewable energy and a “smarter” grid remain challenges to its further development.
Photo by Filter Forge via Flickr
It took us a while to build an EU internal market for electricity. According to the Single European Act strategy of Commission President Jacques Delors, it should have been implemented back in 1992… but that turned out to be only the first stirrings of a 25-year process. There are many “good reasons” why Europe has been so slow, and they are set out in the first part of this paper, entitled “Not easy to do … 1990-2015”. But there’s no denying that today we are entering the last mile of this slow process, even if anti-market arrangements still prevail in many countries. The paper’s second part – “All done by 2015?” – asks whether this whole construction is robust enough, while the third part “Done forever? From 2015 to 2030” will suggest that the EU’s internal electricity market may yet be seriously challenged by two waves of disruptive innovations – renewables and the “smartening” of the energy system.
Not easy to do… 1990 – 2015
Taking a quarter-century to build Europe’s internal market in electricity may seem an incredibly long journey as well as an example of the EU’s inability to accomplish serious industry reforms. But we should remember that no other “federal-style” government of a major country has achieved an internal market for electricity.
The U.S., Canada, Brazil, Russia, India or China have none of them succeeded in opening up a continent-wide electricity market. Let’s turn first to all the good reasons for the EU’s slowness. The project aimed to open up national monopolies’ territories to foreigners, and that of course was widely seen as a radical project that inevitably triggered opposition. The second reason was that there was no wave of technological innovation – unlike in the case of telecoms – to challenge the incumbent energy giants. Third, electricity is a difficult product to trade as it requires hundreds of technical, legal and economical rules and standards to be agreed before it becomes tradable. Electricity is, after all, no more than a coordinated flow of electrons jumping from one atom to the other inside the millions of metallic wires of a gigantic interconnected network. This very demanding market arrangement meant that electricity was for decades considered to be a typical “anti-market” product that was best suited to monopolies and even cartels.
“Electricity is a difficult product to trade as it requires hundreds of technical, legal and economical rules and standards to be agreed before it becomes tradable. Electricity is, after all, no more than a coordinated flow of electrons jumping from one atom to the other inside the millions of metallic wires of a gigantic interconnected network.”
In truth, it has been the communications revolution that has opened the way to new market arrangements in the electricity industry, and made them feasible. New communications technologies have given us the tools to register every move of electricity generators and consumers alike – so permitting one generator and one consumer to trade bilaterally inside a market. The fourth reason is that the various national arrangements between industry players and public authorities cannot readily be merged into a common scheme of interoperable markets.
Several successive packages have been needed to get all EU countries to implement compatible market arrangements. Germany, for instance, did almost nothing to promote compatibility because it chose not to have any regulatory authority but only a cartel of industry representatives. A plague of national barriers fragmented the EU for decades, which is why we needed four packages – the Commission’s three energy ones plus the infrastructure package – to make it work at continental level. The rapid expansion of gasfired power plants in the EU has nonetheless added a common industry factor between many countries and helped them to converge on compatible arrangements. Since the EU’s gas market reforms are far less advanced than those in electricity, we ended up settling for a bit of help from the “gas dash” instead of a complete revolution. And by the end of this first period, the speed at which the industry consolidated into EU mega-giants was much faster than the speed at which national market arrangements converged towards a common EU market platform.
All done by 2015?
If we ask ourselves whether the arrangements being implemented according to the third energy package and the infrastructure package add up to an “EU market”, the answer is yes. In the first place, we Europeans already have a set of national “day ahead” wholesale markets that are mostly connected by “implicit access” to physical interconnections: Any bid accepted in an exchange is simultaneously taken into account by the other exchanges and by the transmission network operators that manage the interconnections. Whenever there is significant congestion of the EU network the European market splits into smaller regional or national markets until the congestion is ended.
Second, we have more and more intraday and “real time” arrangements by which offers of capacity and energy services cross the borders of the electrical zones managed by the TSOs. Third, the network is itself becoming more and more “Europeanised”. New grid operation codes are being conceived at EU level, and a common planning of the EU grid is taking place under the “Ten Year Network Development Plan”. A set of “Projects of Common Interest” are also due to adapt our infrastructures better to the internal market’s needs.
Having said all this, it’s nevertheless true that anti-market arrangements still survive in many European countries. At the retail level, one can still see government price controls in France and many other countries. Sometimes these regulated retail prices are not even aligned with wholesale prices, and result in billions of euros in “tariff deficits”, as is notably the case in Spain. At the wholesale level, byzantine market arrangements can add up to a “re-regulated access regime”, not only in France and Spain but in the UK too in light of its planned new nuclear power stations. These national distortions have significant effects, but they cannot entirely block the internal market’s functioning. However imperfect the EU’s internal market may be, there can be no doubt that we are moving towards it.
Done for ever? From 2015 to 2030
But it is far from guaranteed that this internal market for energy will work forever. The many national compromises that have been realigned and harmonised in successive EU compromises dealt with the past, and were therefore aimed at opening up an EU market as conceived in the 1990s. What we now face in the EU is the new energy policy designed in the spring of 2007 at the European Council in Berlin – the 20-20-20 strategy to be in place by 2020. Add to that the wave of “smart” innovations and there’s a risk we’ll still end up with an internal market headache.
The reasons for saying so are, first, that renewables are being pushed in the electricity sector from outside the market. Both wind and photovoltaic energy (PV) run at the speed of their feed-in tariffs. With virtually no barriers to them entering the electrical system, renewables enjoy considerable advantages: they are always guaranteed access to existing consumption, whereas thermal generation only has access to the remaining demand. In some EU countries, renewables also have the right to connect to the grid, and the grid owner has a duty to invest accordingly. Step by step, a significant proportion of Europe’s thermal power plants are selling less and less energy while providing more and more “flexible capacity” for the electrical system. Some countries like the UK and France are looking at bridging that power generation revenue gap by re-organising their national market’s capacity arrangements. Obviously enough, this might well break up the EU’s internal market as some thermal generators would still be paid only for the energy they can sell, while others would get both those energy revenues and also a national capacity payment.
Second, even if there were to be no capacity splitting of the market, the present wholesale market might well undergo profound changes under the pressure of the growing share occupied by renewables. When large amounts of energy generated by renewables enter the wholesale market, that greatly depresses the market price. The variable cash cost of generating electricity with renewables is low, and a competitive energy market will use the variable cost of marginal power generation to price the market as a whole. That price can easily drop close to zero if the market is flooded by renewable energy. It can even fall below zero into negative prices: when the generators pay the buyers! Because thermal plants face difficulties when reducing their output – they have to contend with huge output start-up costs and other dynamics – they may prefer to pay for the right to keep their plants running. But in depressed conditions of this sort, how can the wholesale Day Ahead market that is the backbone of the EU internal market maintain its central position in the chain of electricity market arrangements that stretches from futures to real time?
“As we can already see that the distribution grids are going to be the core of the EU internal market, the question we should ask is how will they operate and how will they be regulated and monitored?”
Third, an important share of renewable energy isn’t fed into the transmission grid but at distribution grid level. To get an idea of the importance of this, we should understand that historically the transmission system operators managed electrical flows in a way that more or less replicated the trades in the wholesale market. In the electrical system of the future, these flows will increasingly be operated on distribution grids. With the expansion of smart technologies, this challenge may perhaps be overcome. As we can already see that the distribution grids are going to be the core of the EU internal market, the question we should ask is how will they operate and how will they be regulated and monitored?
The problem will be to avoid a situation in which several thousand distribution operators throughout Europe fragment the internal market by spontaneously diverging through myriad different policies. Another step that could push us into this fragmentation scenario is that the smartening of the electrical system will also push millions of consumption units through smart metres and other devices. Many of these consumers will also be producers, thanks mainly to the PV panels that are famously turning them into “prosumers”, and they may therefore have an impact on both the offer and demand sides of these changing energy markets. Nobody yet knows how the corresponding new services – whether communication-related or energy-related – and new markets that are immediately responsive to demand will evolve: will each EU country be different, and each distribution operator?
Building Europe’s very large internal market for electricity has been a slow process of some 25 years, but it has been achieved, and only in the EU, nowhere else. We Europeans conceived our internal market arrangements “our way”, even though many other ways were originally imaginable. Europe could for example, have opened up the wholesale market without opening the retail market. Or it could have made opening the wholesale market mandatory with a centralised exchange system operating a single price algorithm, just as England did for more than 10 years.
In the end, though, we Europeans did it in a way that works, contradicting the thousands who predicted failure, disruption and chaos.
I would conclude, though, by repeating that what we now call the EU internal market is just a compromise between all the other national-level compromises; it’s not a perfect mechanism capable of serving us all whatever the prevailing conditions. It may suffer greatly in the coming years from the effects of a massive increase in renewable energies or from a de-centralisation of the production-consumption loop. The future, now that the European Commission is trying to stimulate debate on the EU’s 2030 horizon, is far from clear.
This is the fifth of a series of short essays that first appeared in the discussion paper EU’s Internal Energy Market: Tough Decisions and a Daunting Agenda published by Friends of Europe on 4 June 2013. We are grateful for the author’s and Friends of Europe’s permission to reprint it here.
In the first article in this series, Jorge Vasconcelos, founder of the Council of European Energy Regulators and Member of the Energy Roadmap 2050 ad hoc Advisory Group, argued that we need to “rethink the single energy market”. In the second article, Fernand Felzinger, President of the International Federation of Industrial Energy Consumers (IFIEC) Europe, expounded the view that the internal energy market should be much more closely linked to Europe’s global competitiveness position. In the third article, David Buchan, Senior Research Fellow at the Oxford Institute for Energy Studies, warned that the internal energy market is being undermined by member states’ reluctance to align their national renewable energy strategies or to depend on one another for back-up. In a fourth article, Johannes Meier and Arne Mogren from the European Climate Foundation argued that well-functioning markets are also essential for decarbonisation.