European Electricity Market Reform

The construction of the energy market in the European Union was first proposed in 1988, being considered as a basic piece in the articulation of a common energy policy and pursuing as its main objective to supply energy products at the lowest possible price with the same conditions of security of supply and quality of service. In 1992 the European Commission formalized a regulatory framework for the creation of the internal electricity market, establishing a timetable for progressively incorporating competition mechanisms in electricity activities. In parallel, the natural gas market was configured following the same scheme of introducing competition.

More than 30 years working on the three pillars (sustainability, competitiveness, and security of supply) of a market that in 2022 we saw it “falling” dramatically. The operating and safety standards were not enough to cushion the impact and now it is time to rebuild it.

The European energy crisis began in the second half of 2021 with the first tensions of the gas market and in 2022 we could say the market breking. This situation has been the embryo of the proposals for change that we now face.

Source: Own elaboration.

 

In the following graphs we can see the terrible effect it had on the main European wholesale gas and electricity markets. This effect acted as dominoes and took away the pillars of the retail market and the safety of the final consumer (contracts, suppliers, industry, etc.).

 

Source: MTech – Magnus CMD.

 

Source: MTech – Magnus CMD and own elaboration.

 

The energy crisis has highlighted the need for a more integrated and resilient energy system in Europe. The proposed restructuring of the energy market is a step towards achieving this objective.  Thus, after concluding a public consultation, the European Commission presented last week a proposal to restructure the energy market to tackle the current energy crisis. The proposed restructuring includes a number of measures to achieve the following general objectives:

  • Accelerate the introduction of renewable energy.
  • Phasing out Natural Gas.
  • Decouple the price of bills from fuel volatility.
  • Protect consumers.

These objectives will require the revision of the different regulations and directives that determine the current functioning of the market (Electricity Regulation, Electricity Directive, Regulation on the integrity and transparency of the wholesale energy market – REMIT).  Specifically, the European Commission’s proposal is aimed at working on the following measures and premises:

  • The proposed reform continues the path of market-based integration of European electricity systems, maintaining the current marginalist mechanism for the power market.
  • Provide the system with more clean and flexible solutions (demand response and storage).
  • Protect and empower consumers: It is intended to provide consumers with a wide range of contracts and clearer information.  Through:
    • Give access to safe long-term pricing and avoid excessive risks and volatility.
    • Obligation for Member States to establish providers of last resort and significantly strengthens the protection of vulnerable consumers.
    • In the event of a crisis, Member States are allowed to extend regulated retail prices to households and SMEs.
    • The rules on the exchange of renewable energy will be revised. Tenants will be able to share surplus solar energy from their roof with a neighbor.
    • Greater flexibility of the energy system, Member States should set targets to increase the flexibility of non-fossil fuels and have the possibility to introduce new support systems, especially for demand response and storage.
    • Enable system operators to achieve peak demand reduction (demand management).
  • Improve predictability and stability of energy costs to boost industrial competitiveness.  Through:
    • Facilitate the deployment of long-term contracts (PPAs). To address the current barriers such as the credit risks of buyers, the reform obliges Member States to ensure the availability of market-based guarantees for PPAs.
    • In order to provide power producers with revenue stability and to shield industry from price volatility, non-fossil electricity generation will have to be in the form of two-way Contracts for Difference (CfDs), while Member States are obliged to channel excess revenues to consumers.
    • the reform will boost liquidity of the markets for long term contracts that lock in future prices, so-called “forward contracts.” This will allow more suppliers and consumers to protect themselves against excessively volatile prices over longer periods of time.

The European Commission has set itself the objective that the future reform of the European electricity market enters into force before next winter, so that consumers and the system in general can already benefit from some of its measures since then in the event of a repeat of a scenario of high prices.

Conclusion: While the measures proposed by the Commission have a clear objective, their implementation may not be so easy.  EC proposals must be discussed and agreed by both the European Parliament and the EU Council of Ministers (representing national governments) before they can become binding. They usually undergo changes in this process.  A period of debate and negotiation opens before these become realities and meanwhile, the market is desperately asking for a framework of legal certainty that ensures the investments required by the European electricity system.

In our opinion, the most convenient thing would be to agree in an agile way the elements of consumer protection and  reconsider or limit that higher participation and autonomy of the member States in the national electricity markets as they could lead to an interested implementation of the measures presented and hinder a strong signal of the single European energy market.

CfDs, PPAs, capacity markets, as well as demand-side management markets represent a paradigm shift for investors as European market signals on the value of electricity at specific places and times would lose their relevance in guiding investments.

In the proposal of the European Commission it seems to give relative freedom to each Member State to design these instruments and in the coming months we will see how the package of rules to be implemented is being shaped. Meanwhile, uncertainty does not help and continues to limit both the investor and the consumer.

Alejandro De Roca | Energy Consultant

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