The Choices & Changes For EU Electricity Market Redesign

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Originally published on Energy Post.
By Sonja van Renssen

The EU is on the verge of a full redesign of its electricity market. Market rules need to be updated to the reality of a much more decentralised system where renewables and the consumer are king. This is the essential next step in the European energy transition. It is an opportunity for policymakers to shape the future. What will they do? Based on leaked documents and conversations with Brussels insiders, Sonja van Renssen explains what choices and changes are ahead.

On 15 July, the European Commission will take a concrete step towards fleshing out its vision for an Energy Union for Europe. It will for the first time unveil its thinking on how the European electricity market should look in future and according to what rules it should function. We expect two strategy papers, one dedicated to the wholesale market, the other to the retail market.

Drafts of both papers have been leaked in the past few weeks (see the wholesale and retail drafts on EU twitterer Alice Stollmeyer’s blog). A look at these documents provides a good insight into what the EU intends to do next. Note that they are the start, not the end of Europe’s electricity market redesign, however. The wholesale paper is indeed a consultation that comes with a long list of questions to stakeholders. Legislative proposals are due next year.

Recent studies on the EU’s electricity market redesign

What is reassuring is that many of the Commission’s draft recommendations tally nicely with those of varied stakeholders and experts of late. A raft of new studies and position papers has appeared, including from the European Wind Energy Association, EWEA (a position paper on market design), the German branch of the World Energy Council, WEC (an analysis of the benefits of further electricity market integration), FTI-CL Energy, a team of energy experts from FTI Consulting and its subsidiary, Compass Lexecon (more recommendations for an electricity market redesign, on behalf of six energy companies) and the Institut Francais des Relations Internationals, Ifri (a study on EU electricity networks and the energy transition). Energy Post also hosted the launch of a previously internal EDF analysis of the European energy system with 60% renewables. 

The goal of the redesign is that of the Energy Union: to see through a successful transition to a more secure, affordable, sustainable energy system. “In the 1990s, it was all about market integration. Now the policy priorities are decarbonisation and security of supply. Market design needs to evolve to give incentives for those priorities,” explains Fabien Roques, co-author of a new study from FTI-CL Energy (see box) called “Toward the Target Model 2.0: Policy recommendations for a sustainable EU power market design”. This was launched in Brussels on 29 June.

“Historically, power market development has focused on day-ahead energy market coupling,” continues Roques. “It was the right focus ten years ago. But now, it should be about markets closer to real-time such as the intra-day market, long-term investment signals, and services beyond energy supply such as balancing.” The EU’s 2009 renewable energy directive led to a surge in renewables that has left conventional generators, grid operators, and indeed regulators and policymakers scrambling to catch up.

Today’s electricity market faces two new kinds of integration challenge: 1) renewables and 2) consumers. In its draft papers, the Commission gives an idea of how it believes these should be tackled – then asks stakeholders what they think.

Sample questions from the Commission to stakeholders:

*Should renewables providers take on balancing responsibilities?

*Are prices that reflect actual scarcity important?

*Should the EU consider legal means to align fragmented balancing markets?

*What is the role of long-term contracts to drive investment in new supply?

*Should national support schemes be more coordinated or opened up to others?

*Should “regional security coordination initiatives (RSCIs)” such as Coreso take on operational work? Could energy security be a regional responsibility?

*Should it be compulsory to offer an end-user demand response?

*What is the role of distribution system operators (DSOs) in data handling and privacy?

*Should there be a European approach to distribution tariffs?

*Should there be a harmonised methodology to assess generation adequacy?

*Would it be useful to create reference models for capacity remuneration schemes and cross-border participation? 

Making the most of the market

Short-term cross-border markets are core to the redesign, says the Commission. The value of operational flexibility, so important when variable renewables start to dominate, is best captured by these markets. Balancing zones will have to be bigger than today. “Most importantly, an EU-wide system for cross-border intra-day trading needs to be set up,” the Commission writes.

Long-term price signals are equally important (on the decarbonisation front, this will also come from a reformed EU Emission Trading Scheme, ETS, the Commission notes). These signals should be market-based and available to all energy market players, whether demand or supply side, to drive new investments where they make sense. Part of this means letting the electricity price shoot upwards when demand peaks, the Commission says. But a wholesale price peak does not have to translate into a retail price peak, it adds. Market players can use a suite of financial products to protect customers from price swings and translate uncertainties into predictable revenues. This boils down to a transition to a market design that complements marginal pricing with some mechanism to support fixed cost recovery. Long-term contracts can help mitigate investment risk for renewables in particular, but must conform to competition law.

The Commission also wants to give consumers easier and more frequent access to consumption data (most get it just once or twice a year now) and it wants to instigate a review of what’s included on bills

The big question is: will the market be able deliver a wholesale price that is sufficient to remunerate existing investments and drive new ones? Some, such as Hans ten Berge, secretary general of Eurelectric, believe the market can deliver and even without long-term contracts. “Do you need a long-term contract when you can find solar panels in IKEA?” he asked in Brussels this week. Ten Berge admitted that utilities have to completely rethink their business model and will face competition from new players, but insisted on a market-led approach.

Renewables should be fully integrated into the market, says the Commission too. This includes “balancing their portfolio” and contributing to increase system flexibility. “If necessary, existing provisions excluding particular means of power generation from normal market rules have to be revisited.”

A successful redesign also depends on getting the grid right. More interconnections will allow for a smoothing effect between the weather patterns in different countries for example. The Commission will come forward with a strategy next year for reaching a 15% interconnection target for 2030, it says. The MEP leading work on this issue meanwhile, has called for the target to be reassessed on the basis that it is an extension of an earlier target dating from before the era of renewables and climate policy. Green MEP Peter Eriksson wants the Commission to “assess the setting of regional, complementary targets and to find better qualitative and quantitative benchmarks, such as peak flows and bottlenecks, that highlight how much interconnection is needed”. In other words, he’s not convinced by the blanket target.

New Deal for consumers

Market integration must be extended to the retail level so that consumers have “the possibility of active and beneficial participation in the EU’s energy transition”, says the Commission. Its priorities for the retail market are: 1) consumer empowerment 2) smart homes and networks and 3) data management and security. It is considering turning to legislation to push these priorities through.

First, the Commission will next year consider legislation to enforce ten minimum smart meter functionalities it recommended back in 2012 (member states’ roll-out plans include these just half the time). Second, it will consider legislative proposals to give consumers access to, and full use of, a smart meter if they want one. Third up is a threat to revise legislation to “strengthen minimum requirements on comparison tools and switching” – customers aren’t switching energy supplier often enough. It will complement this with a code of conduct for advertising offers to make it easier for consumers to compare competitors. The Commission also wants to give consumers easier and more frequent access to consumption data (most get it just once or twice a year now) and it wants to instigate a review of what’s included on bills.

Phasing out price regulation is still very much on the agenda and the Commission plans to draw up fresh guidance for member states on a “phase-out roadmap” albeit “with targeted measures to protect vulnerable consumers”. A new study on energy poverty, published on 25 June, shows that less than a third of member states explicitly recognise energy poverty. The authors make numerous recommendations for how especially through energy efficiency measures targeted at vulnerable consumers, policymakers can best address it. The Commission plans to launch an EU-level observatory for energy poverty this year.

DSOs will not only have to make grids smarter, but actively operate and balance them. For this, authorities will need to give them the right incentives and tools

Consumers are entitled to “price signals that reward flexible consumption” as a way to cut their energy bills, the Commission says. This can mean contracts that distinguish between peak and off-peak periods, or dynamic pricing linked to wholesale prices for example. Dynamic pricing should be extended to network costs, suggests the Commission. That means consumers would pay less if they cut consumption when networks are congested. Consumers should also be able to sell their “flexibility” to balancing and wholesale markets. The Commission plans to work with national regulators to draw up principles for commercial demand response and examine how to improve access for households. This includes checking out the effect of current laws on aggregators and energy service companies (ESCOs).

Self-consumption “should not be prohibited by measures such as obligations to sell domestically produced electricity to a third party, nor should unjustified or disproportionate financial charges be imposed on self-consumed energy”, the Commission says. Yet Spain’s new “sun tax” appears to do exactly this! It slaps charges on micro-generation. What might happen to it in future is unclear; the Commission stops short of proposing to mandate its recommendations on self-consumption.

On the ICT and energy front, the Commission intends to update its guidance to member states and industry on how to carry out an impact assessment of data protection in the energy sector in 2016. It will report on best practices and best available techniques for mitigation cyber-security risks in smart grids.

Finally, the role of distribution system operators (DSOs) is up for debate. Most renewables will be plugged into the distribution grid. DSOs will not only have to make grids smarter, but actively operate and balance them. For this, authorities will need to give them the right incentives and tools. “DSOs should be neutral market facilitators to enable the development of market-based services to consumers by third parties,” the Commission says. It adds: “The DSOs increasingly face similar challenges and share common interests with TSOs.” The Commission will launch a forum for dialogue between the two to push cooperation. It will also work with energy regulators to define “common procedures for the management of local constraints in the distribution networks”.

Renewables go regional

The EU is going regional on many fronts. One that has been coming to the fore of late and that is evident in the leaked redesign drafts is a more regional approach to renewables development. The Commission has long pushed for more cooperation on renewables, but with little success. This was in part because countries had no problems meeting their national renewable targets.

In its recent biennial renewables progress report however, the Commission calls for an increase in cooperation. This could be one country buying surplus renewable energy from another or the development of joint projects or even joint support schemes. At an EU Sustainable Energy Week (EUSEW) in June, Commission director for renewables Marie Donnelly said cooperation was the natural alternative to nationally binding renewables targets in an integrated European market. Europe has an EU-wide target of 27% renewables for 2030, but no national targets anymore.

Some argue that the entire price problem in the European wholesale electricity market today can be explained by a surplus of generation capacity

The Commission is also mulling a “framework for cross-border participation in support schemes”. Any attempt to harmonise support schemes has been met with serious opposition in the past, however. During EUSEW, a Commission official reportedly suggested that renewable energy subsidy auctions could be a path towards convergence. He spoke at the launch of an EU-backed research project on auctions, which are already favoured under new EU state aid guidelines adopted last year. Many argue however, that auctioning will kill off smaller, citizen-led projects. The European Renewable Energy Federation (EREF), which unites national renewables associations, took the Commission to court last September calling for the state aid requirement to phase in technology-neutral, auction-based subsidy schemes to be annulled. For this, it invoked nothing less than member states’ right to choose their own energy mix under the EU Treaty. The case is in progress (T-694/14).

“There is a political constraint to better spatial distribution of renewables,” explains one EU source, who spoke on condition of anonymity. “Only much better regional cooperation on agreed legal frameworks is a way around this. We should agree these frameworks before discussing renewables locations. Principles are much easier to agree on than where to spend money.” The North Sea is the furthest along on this front, he added.

Single capacity mechanism template

Despite better functioning short and long term markets and in particular peak prices that work as investment signals, some member states foresee insufficient generation capacity going forward, notes the Commission. They have introduced, or plan to, capacity mechanisms which mean “making separate payments for available capacity rather than paying for electricity delivered”. France, Italy, the UK, Spain, Portugal, Italy, Greece and Ireland all offer capacity payments of some sort, the Commission says. It’s quick to add that these are often costly, distort the market, and run counter to the idea of phasing out fossil fuel subsidies – never mind all subsidies – in the long term.

In the past, the Commission has already asked public authorities to regularly undertake a generation adequacy assessment. This is currently done very differently in different member states, it says. This should be standardised. The Commission also proposes to “lay out a reference model for a capacity mechanism (or a limited number of mechanisms) for use on a regional basis” to facilitate cross-border participation. The current sector enquiry into capacity mechanisms can help develop this template, the Commission says.

Europe is at the start of a long and complex process to overhaul its electricity market

At the same time, some, such as Michael Hogan at the Regulatory Assistance Project (RAP), a group of independent energy experts, argue that the “entire price problem” in the European wholesale electricity market today can be explained by a surplus of generation capacity. The FTI-CL study mentioned above suggests this is a structural not a temporary problem. Part of the case for investment in the energy market may therefore be made by the retirement of existing generators. Germany took a step in this direction on 1 July with the decision to put 2.7GW of lignite capacity into a capacity reserve. More may be put in over time. This gives the country an insurance policy for energy security and helps it cut CO2 emissions.

Europe is at the start of a long and complex process to overhaul its electricity market. This will involve plenty of legislative action going forward, from a revision of the EU’s electricity security of supply directive to a new renewable energy law next year. Coming up with a vision for how the electricity market should look and work, is the first step. Market models are not system neutral, or neutral regarding the types of choices governments can make. The market will become more European and more elaborate. But as long as national politicians remain politically responsible for their citizens, Brussels will have to fight hard for change.

Reprinted with permission.