Watt laws? What is the best electricity market design of the future?

Hans ten Berge

Twenty years after the entry into force of the First Energy Package, the upcoming review of the EU electricity market design is a unique opportunity to push the European agenda forward and anticipate the future challenges of the electricity sector, which is rapidly transitioning towards a low-carbon economy.

This transition is unprecedented and its pace is difficult to foresee. It will bring about innovation and opportunities as well as challenges. Lots of questions still remain open today: when will existing power plants close and new investments happen? How to design a new electricity market able to provide adequate flexibility to consumers? When will new technologies, like storage, be broadly implemented? What will be the role of the energy industry in the next 30 years?

Decarbonisation of the power sector is essential to guarantee the long-term sustainability of the EU and global economy as there is currently no energy carrier that can decarbonise to the same extent and scale as electricity. In 2014, 56% of electricity generated in the EU came from low carbon sources: 28% was generated from renewable energy sources (RES) and 27% from nuclear. Given our commitment to a carbon-neutral power sector by 2050 and to help electrify other sectors like transport, heating and cooling, we believe that a revived electricity market design is key.

Empowered customers will play a crucial role in the next decades. Using the most modern technologies such as heat pumps, electric vehicles, home management systems and connected objects, customers will have unprecedented control over their energy use. The need to integrate increasing shares of variable renewable energy sources (RES) into the system makes demand side flexibility more and more relevant. These developments require clear rules which enable participation of customers in the market and a fair competition between all resources (generation, demand response, storage).

In order to better integrate final consumers into the system, retailers should be allowed to develop innovative products such as retail offers that incentivise efficient response from customers. The structure of retail prices today creates distorted investment signals and losses of social welfare. Policy support costs collected through electricity consumers’ bills hamper electricity’s competitiveness against other fuels, which slows down electrification. In addition, most of the regulated costs that are behind customers’ bills, such as network costs and policy support charges, are fixed and thus do not depend on the volume of electricity consumed.

Yet, due to regulatory requirements, they are mostly collected on a volumetric (€/kWh) basis. This price structure leads to distorted investment signals (especially in self-generation) that result in increasing retail prices for all consumers who remain solely supplied via the grid. This could in the end lead to a “consumer divide” as the number of consumers connected to the grid continues to shrink and the unit price of electricity increases.

The internal electricity market must be urgently completed. The Third Energy Package and the integration of wholesale markets across all timeframes through network codes is the cornerstone of the electricity market design. To effectively make the market fit for renewables, we must ensure the full integration of day-ahead, intraday and balancing markets, and implement shorter gate closure. Wholesale prices must also be allowed to adequately reflect scarcity, thus helping to provide investment signals that can be trusted by market participants.

As we progress slowly but steadily towards an integrated European electricity market, renewables must be increasingly exposed to competition and be placed on a level playing field with other technologies. Next to our decarbonisation objective, we are committed to a European binding objective to achieve at least 27% of renewables by 2030.

The post 2020 framework for renewables must therefore ensure a coherent approach that takes into account the contribution of all sectors – heating, cooling, electricity and transport. In the transition phase, the EU ETS should be the main driver for RES investments in the electricity sector. It is an established, technology-neutral instrument that can bring an increasingly EU-wide approach to low-carbon technologies. Strengthening the EU ETS is therefore a no-regret option to increase the competiveness of low-carbon technologies such as RES and nuclear, and encourage fuel-switching to low-carbon sources.

It is nevertheless likely that some Member States will continue supporting RES after 2020 as the current market conditions and EU ETS price do not provide sufficient investment signals. Support schemes should be market-based, such as competitive tenders, ensure cost-efficiency, minimise distortions in the wholesale market and minimise the capital cost of investments. Recently, some schemes have evolved from FiTs (feed-in tariffs) to FiPs (feed-in premiums) or CfD (contracts for difference) and elements of tendering are also being introduced for larger units, in line with the state aid guidelines. For instance, feed-in tariffs should be phased out, because they do not allow market integration.

Developing a robust cross-border intraday and balancing markets will be crucial to ensure that the system remains balanced as the share of renewables continues to grow. To ensure operational integration of all renewable electricity generators into the market, further steps are needed. It is necessary to move towards putting operational market responsibilities on all participants, either directly or indirectly through a service provider, including balancing responsibility.

Another key element is to have common rules to deal with congestion management. To provide an efficient dispatch system in case of congestions, cross-border redispatching measures should be defined based on a common method to calculate regional capacity, fast recomputations, integrated market-based redispatch mechanisms and a fair allocation of redispatching costs across countries.

Through this transition we will need to provide security of supply to European households and businesses. To this end, we support a more regional approach to security of supply. EURELECTRIC welcomes the new methodology developed by ENTSOE to assess system adequacy on regional and European level.

Further improvements are nevertheless necessary, such as the introduction of parameters sensitive to the demand (e.g. GDP, demography growth rates, energy efficiency gains, etc.) or the supply side (economic viability of existing assets, development of RES capacity etc.). In particular, capacity uncertainty on the supply side should be duly taken into account: it deserves high-level economic sensitivity analysis to evaluate if the expected capacity is likely to stay online in the future.

 The metrics to define these adequacy targets should be harmonized at regional level to allow for a straightforward comparison of targets in different countries and they should be both homogeneous and transparent to let the market understand the outcome. While countries should be free to set their desired level of adequacy, in integrated markets, these target values should naturally converge to prevent the side-effects of significantly different target levels across Member States, such as free-riding. Member States should decide how to ensure regional security of supply in cooperation with their neighbours, while ensuring the availability of contracted cross-border capacity. In case of common scarcity events, TSOs’ actions should be clarified and factors in the adequacy assessment.

As made explicit by the DG COMP inquiry into capacity mechanisms, many Member States are already introducing different types of capacity mechanisms to ensure security of supply. This in depth analysis sheds light on the security of supply challenge and on existing instruments.  EURELECTRIC agrees with DG COMP on key features for capacity markets: they should be open to generation, demand response, storage, and also allow for the contribution of capacities across borders to drive regional cooperation and take into account regional interdependencies. Well-designed capacity markets contribute to giving longer term investment – or divestment - signals to ensure security of supply.

Well-designed capacity markets deliver system adequacy in a sustainable way by valuing reliable and firm capacity and thereby providing signals for competitive existing capacity to stay online or new capacity to be developed in order to reach system adequacy targets. The overarching goal of any capacity market must be to ensure system adequacy, in other words firm capacity provided by conventional and renewable generation, demand response and storage assets. Having a market-based capacity mechanism that is open to all technologies throughout the whole value chain and that does not discriminate between new and existing plants is the most cost-efficient way to reveal which capacity providers should be remunerated to ensure system adequacy.

Market designs are not carved in stone and should evolve with the energy transition. In the short to medium term the critical challenges are to foster the competitiveness of low-carbon technologies, to allow for the development of flexible solutions, to ensure that the market provides price signals adequate for existing assets and investments, and to avoid structural over or undercapacity, thus ensuring security of supply in a cost-efficient way.

To allow for the energy revolution to be carried out in the most cost efficient way, customers, energy companies and policy-makers have the responsibility to help designing a regulatory framework and adequate governance which is adapted to the needs of the moment, forward-looking and able to flexibly adjust to the challenges ahead. Technology is clearly leading the way, all the others should be able to cope.

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