A Reform Proposal for a Future-proof EU Electricity Market

Content

Summary

The European Commission has now presented its proposed reform of the EU’s electricity market.

The reform consists of two proposals. The first updates the regulation of the wholesale energy market and the role of the regulator, and the second addresses the EU’s market design.

The reform, which realistically will not enter into force earlier than 2025, does not drastically change the controversial elements of the EU market.

Rather, it adds dampening tools to reduce short-term price fluctuations, while incorporating new elements that could make the market better suited to deploy the (variable) renewable generation required to meet the EU’s climate targets.

To reach such targets, the European Commission proposes a central role for long-term contracts such as Power Purchase Agreements and contracts for difference. It also introduces more contractual flexibility for consumers and more options for energy sharing.

While the basic scheme remains, if used extensively and consistently across the EU, the proposed new elements may enable a non-traumatic, gradual transformation of the electricity markets.

Much Forward-looking and Fine-tuning To Stop the Market From Squeaking

On March 14, 2023, the European Commission (EC) presented a reform of the EU’s electricity market design as planned, following the corresponding public consultation initiated on January 23, 2023.

This reform is part of the Green Deal Industrial Plan, which was launched in February 2023 and formally presented through two regulation proposals (Communications). These will now go through the ordinary legislative procedure to be approved (adopted):

COM(2023) 147 to improve the European Union’s protection against market manipulation in the wholesale energy market.

OM(2023) 148 final to improve the European Union’s electricity market design.

Despite the EC’s ambitions for an expedited process, the reform is unlikely to be approved before 2025, considering the complexity and the usual length of the discussion process. And, following adoption, it will require transposition to national legislation across the member states. Therefore, we do not expect to see any real impact of the regulation until the final years of this decade.

Officially, the reform aims to make the EU energy market more resilient, and to better protect the energy bills of European consumers and companies from short-term market price swings. The more drastic and subtle market reform options have been the subject of intense debate during the drafting process. But as hinted by the leaked draft, the reform does not seek to reformulate or replace any of the most controversial elements of the electricity market – such as the role of marginal pricing – nor does it propose a particular new design based purely on any of the intervention options in the toolbox of possible reform designs. In layman’s terms, rather than replacing the most controversial market mechanisms, it adds new, flexible elements to reduce the impact of short-term and marginal pricing. The two new key elements aim to:

Make electricity bills less dependent on fossil fuel prices by promoting specific contracts that help create a buffer between short-term markets and the electricity bills paid by consumers. On the consumer side, it ensures that all citizens have the right to choose long-term fixed-price contracts. On the producer side, it introduces a central role for Power Purchase Agreements (PPAs), and for two-way contracts for difference (CfDs) for new investments in low-carbon generation where public funding is required. Rather than reviewing the short-term price formation, the reform promotes contracting schemes that are less dependent on short-term price.

Enable the market to better accommodate the renewable generation needed to reach the EU climate targets. This means that the reform includes measures to facilitate the integration of renewables and to ensure more flexibility.

Protecting the Wholesale Energy Market From Manipulation

Proposal COM(2023) 147 aims to “complement the short-term markets with a greater role for longer-term instruments, allowing consumers to benefit from more fixed-price contracts, and facilitating investments in clean technologies.”

To this end, the proposal updates Regulation (EU) No 1227/2011 on wholesale energy market integrity and transparency, and Regulation (EU) 2019/942 for the European Union Agency for the Cooperation of Energy Regulators (ACER). The proposal:

Increases the types of possible contracts, establishing the consumer’s right to choose between multiple fixed-price contacts and dynamic price contracts, as well as the right to better contract information.

Provides access to regulated retail prices for households and SMEs in the event of a crisis. It also requires that suppliers shield consumers against high price spikes by making greater use of forward contracts locking in future prices. It requires member states to establish a supplier of last resort regime. This refers to the process that kicks in if an energy supplier cannot meet its obligations – in which case continuity of energy supply is guaranteed.

Establishes the right to share renewable energy directly among consumers,without the need to create energy communities.

Enhances market access to more stable longer-term contracts, specifically PPAs. Member states should be reducing the financial risks associated with off-taker payment default in the framework of PPAs. To stabilize prices, investment support should be structured as two-way CfDs, which set a minimum guaranteed price but also a maximum price, so that any revenues received above that ceiling are paid back by the power generator. The proposal will apply to new investments in power generation.

Reinforces the regulator’s capacities to monitor the energy market and its transparency. It establishes an enhanced role for ACER.

Requires member states to assess their needs for power system flexibility and to establish objectives regarding the flexibility needs.

Establishes an enhanced role for transmission system operators (TSOs) to integrate renewables into the grid.

Improving the EU’s Electricity Market Design

Proposal COM(2023) 148 final shares the objectives of COM(2023) 147 but addresses the required changes in the market design. It updates Regulation (EU) 2019/943 on the internal market for electricity. It includes market-specific elements, such as boosting the use of demand response and storage, or the mandate to TSOs and Nominated Electricity Market Operators to organize the management of the integrated day-ahead and intraday markets.

First Reactions

Both opponents and proponents have already commented on the proposals. For example, BEE, the German Renewable Energy Federation, is “clearly critical on the draft” (in German) and rejects the mandatory introduction of two-way CfDs at the EU level. On the other hand, BEUC, the European Consumer Organisation, welcomes the draft as a great win for consumers. And in between, ENTSO-E, the European association for the cooperation of TSOs “supports key aspects of the electricity market design reform proposals but sees room for improvement.” As is often the case, the reaction depends on the position of those involved.

Highlights

The EC has proposed a gradual upgrade of the EU’s electricity market to make it more fit for the future and resilient to current disruptions. That is not a straightforward, clear-cut task. Yet, in our opinion, the path chosen in the first draft proposal adequately identifies the key areas where action is needed, and seems to choose for non-disruptive, enabling instruments.

While the draft may still evolve until final approval, there is no doubt that it contains elements that will contribute to a new way of investing, producing, delivering, and consuming electricity. To what extent these will be sufficient will be at the center of the debate, and will depend on the details of final implementation left to member states.

In our view, both draft proposals to reform the EU’s electricity market are sensible starting points aimed at balancing the introduction of new elements without disrupting the (reasonably) functioning market we currently have, while simultaneously oiling the squeakier parts of the market that keep power cables working.

Research

A Reform Proposal for a Future-proof EU Electricity Market

Pablo Ruiz

Susan Hansen