The EU has made progress in integrating its markets, but there is still a long way to go, argues Jorge Vasconcelos, founder of the Council of European Energy Regulators and Member of the Energy Roadmap 2050 ad hoc Advisory Group. Europe needs a reinvented energy market and technological developments can help that to happen. “Strong wind and sunshine can literally blow conventional electricity markets to pieces if high penetration rates of wind and solar generation are attained without proper adaptation of ‘the stuff we have’.”
Shakespeare said it all in his little-known play “Pericles, Prince of Tyre”: “But shall I search the market? What else, man? The stuff we have a strong wind will blow it to pieces, they are so pitifully sodden. Thou sayest true; they’re too unwholesome, o’ conscience.”
All markets are social constructions of some sort, whether they are the slave markets of the past mentioned by Shakespeare or electricity markets of today. And like buildings, some markets are ancient, resilient, efficient and admired, while others are short-lived, fragile, defective and scorned. But unlike diamonds, markets are not forever: they exist to serve the social needs of their time. Markets are an ingenious human achievement; they are neither a reproduction of natural processes nor the logical outcome of abstract reasoning. As Nobel laureate Ronald Coase pointed out, “the creation of new markets is frequently complicated and sometimes even thwarted by ideological enmity, political resistance, fear of uncertainty, or mere ignorance.” His definition applies neatly to the EU’s internal energy market (IEM).
The IEM project set out to simultaneously meet two goals:
- To liberalise Europe’s electricity and natural gas markets, and so allow energy consumers to benefit from competitive prices through the play of market forces. It was an ambition being embraced by many governments around the world in the late 1980s and early 1990s.
- To contribute to the “ever closer union” proclaimed in the Treaty of Rome in 1957 and re-stated by the Single European Act of 1986 when December 31, 1992 was set as the deadline for the EU’s single market.
Twenty years later, the single European energy market is still not a reality. Political resistance, fears of uncertainty, ignorance and entrenched economic interests all bear a share of the responsibility. Yet even though it wouldn’t be accurate to describe the present situation as a single market, much has in fact been achieved over the past two decades, so it would be equally inaccurate to describe the result as an irremediable failure. From a legal standpoint, the EU has built the largest integrated electricity and natural gas markets in the world, serving the largest world economy, even if they are not yet fully integrated physically or in terms of price. EU member states’ national electricity and natural gas markets are fully liberalised, at both wholesale and retail level and some of these national markets have successfully built strong links with neighbouring markets, thus widening the choices available to consumers and enlarging suppliers’ customer basis.
But Europe now faces two simultaneous challenges. The first is to complete the IEM and achieve truly integrated European electricity and natural gas markets. This is both an economic necessity and a political imperative. The second is to reinvent the whole concept of the energy market to take account of recent and coming technological developments, together with the environmental goals set out by EU leaders in March 2007 (establishing an “integrated climate and energy policy”) and October 2009 (“to reduce emissions by 80-95% by 2050 compared to 1990 levels”).
Instead of becoming larger, more liquid and more robust, Europe’s electricity markets seem to be shrinking, losing liquidity and becoming more volatile and therefore fragile.
To complete the IEM, policymakers, industry and regulators need to deliver on a number of crucial actions. That means the strict and timely implementation of existing legislation, the abolition of all current market distortions and the prevention of new ones being introduced. Twenty years of legislation and extensive jurisprudence means it would be useful to bring all these elements into a coherent and simplified legal framework for energy. This task should not distract the European CommCommission from its essential role as watchdog and enforcer of EU law.
Appropriate regulation needs to be introduced at EU level. The Agency for the Cooperation of Energy Regulators (ACER) that was established in 2009 needs to be upgraded to make it a truly effective IEM regulatory agency, because having EU markets without EU regulators poses a major problem. If that isn’t done, market fragmentation will be a continuing threat and unilateral policies and regulatory decisions will jeopardise energy market efficiency and energy system reliability. This is an institutional change that will require strong political will and innovative legal solutions. Energy regulation at EU level is now as urgent as that of the EU’s financial markets.
Energy infrastructures must be expanded and upgraded, particularly where cross-border inter-connections are concerned, so as to enable the full integration of national markets. This is not so much a financial problem as a political, administrative and regulatory one.
Tight operational coordination at EU level needs to be introduced, with the clear assignment of responsibilities to the appropriate EU electricity and natural gas bodies and to the respective national system operators. Without proper operational coordination, existing and new transmission assets will remain under-utilised, with an increased risk of black-outs and gas supply disruptions.
Energy infrastructures must be modernised through the systematic introduction of modern information and communication technologies (ICT). This will improve the planning and operation of energy systems, whatever their configuration. It will also improve the functioning of Europe’s energy markets, both directly because more and more reliable information will be available to market agents, and indirectly through the more efficient use of physical infrastructure the better to enable energy trade. ICT also has a decisive effect on enabling demand participation in energy markets, the development of energy efficiency services and a large-scale deployment of electric vehicles. The “green economy” may well make a substantial contribution to growth and job creation in Europe.
Besides these points, there are a number of other features that represent a threat to electricity market efficiency and integration. Instead of becoming larger, more liquid and more robust, Europe’s electricity markets seem to be shrinking, losing liquidity and becoming more volatile and therefore fragile. By decreasing energy demand, the economic crisis is reducing market liquidity, and though it’s to be hoped this is temporary, there are other structural factors that can be expected to have a long-lasting impact on market liquidity.
In my view, both market sceptics and political cynics are wrong, because they underestimate the disruptive role of technology
The first of these is energy efficiency and conservation. Reducing energy demand by 20% as compared to the business-as-usual scenario is one of the EU’s 2020 energy and climate policy goals. Less demand means less market volume.
A second factor is the increased amount of subsidised electricity, mainly from renewable energy sources and co-generation. Because it is directly subsidised,this does not compete with conventional generation in “conventional” markets. This type of “off-market”, “must-run” generation is expected to increase substantially up until 2020 and onwards.
Third, some large industrial consumers and electricity producers such as those based on nuclear power generation are promoting long-term contracts, and so further reducing conventional market liquidity.
And fourth, increased protectionism may lead to a slow-down in the construction and use of crossborder interconnections.
With a 20-year missed deadline, “completing the IEM” can no longer have the same meaning as was initially foreseen. Energy markets were then expected to deliver competitive prices and provide customer choice. And the general belief was that efficient markets would also enhance security of supply and provide suitable environmental protection. But since then, public policies have changed and now energy markets are not only expected to deliver competitive prices but also make a decisive contribution to creating a low-carbon economy.
The impact of these policy changes is not to be ignored. In early 2011, the European Council stated that “reducing greenhouse gas emissions by 80-95% by 2050 compared to 1990 as agreed in October 2009 will require a revolution in energy systems, which must start now.”
Looking back at the difficulties encountered during the creation of electricity markets, and considering their current weaknesses and imperfections, some observers believe that Europe’s electricity markets will not be able to withstand the growing pressures of these changing public policy requirements. They warn that they will eventually collapse, leading to a “re-monopolisation” of the electricity industry. Others think that the present public policy goals are too ambitious and too expensive, and therefore cannot be achieved. They believe that policymakers will soon realise how such policies collide with hard market realities, and that governments and the EU will consequently have to recognize the need to soften these policies. It will be policies and not markets that will eventually collapse, according to those observers who stick to the “classical” energy market model.
So is a choice between market failure or policy failure the only one we are left with? Is there a way to escape this dilemma by reconciling efficient markets with ambitious policies?
In my view, both market sceptics and political cynics are wrong, because they underestimate the disruptive role of technology. It is very difficult – perhaps even impossible – to reconcile, at least in a cost-effective way, some policy goals with current electricity markets. But the introduction of new technologies will change the physical functioning of electricity systems, and as a result the functioning of electricity markets. The application of new technologies to energy systems, in particular ICT, will affect the way energy systems are planned and operated, and the way energy markets work. ICT has the potential to make energy and climate policies effective and electricity markets efficient. ICT may contribute simultaneously to improving market efficiency, facilitating the implementation of public policies and adopting market-based mechanisms to implement renewable and energy efficiency policies.
These hopelessly antediluvian patriarchs seem to envisage the energy industry as a Noah’s Ark escaping the internet’s flooding
Technology is not a magic solution to all market inefficiency problems or to policy implementation difficulties. What technology does allow for is the design and implementation of market-based mechanisms and incentives that enable a growing number of public policy goals to be met within the regulatory framework of liberalised electricity markets. Policy and regulatory innovation is needed to support technological innovation, thus keeping markets alive and functioning well, and to ensure that policies are implemented cost-effectively.
Identifying and optimising the benefits of ICT for energy systems and markets is the big challenge being faced by the energy industry and its regulators. Those who would deny the need for a revolution in energy systems sometimes pretend that ICT will have little or no impact upon energy markets, and so they advocate managing or regulating the energy industry on a basis of business-as-usual.
They overlook, though, the dramatic impact of ICT upon our private lives, social relations and economic behaviour. These hopelessly antediluvian patriarchs seem to envisage the energy industry as a Noah’s Ark escaping the internet’s flooding. Others are so excited about ICT’s apparently infinite possibilities that they overlook the physical laws, economic restrictions and cultural inertia governing energy systems. They dream of the birth of a brave new “internet of energy” world.
What is urgently needed now is a realistic design for the transition process from today’s low-ICT, high-carbon energy systems to a high-ICT, low-carbon system of tomorrow.
“The stuff we have, a strong wind will blow it to pieces.” Strong wind and sunshine can literally blow conventional electricity markets to pieces if high penetration rates of wind and solar generation are attained without proper adaptation of “the stuff we have”. After 20 years, this “stuff” is pitifully sodden, too unwholesome and needs to be replaced anyhow. To find the appropriate replacement one will “search the market” for market-based solutions. But searching the market will nonetheless be interpreted as actively looking for “new stuff”, not as “old market soul-searching”.
This essay first appeared as part of a discussion paper – EU’s Internal Energy Market: Tough Decisions and a Daunting Agenda – published by Friends of Europe on 4 June 2013. It is reprinted here with permission. In the coming weeks we will feature a number of other essays from this publication.