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The New EU Electricity Market Design: More Market, or More State?

As a new regulatory design for the EU electricity market is taking shape, there are grave concerns in the sector that the new rules will not advance the internal energy market very much. Or might even undermine it. Energy Post editor-in-chief Karel Beckman talked to a number of key players in the sector who will debate the proposed market design rules at an Energy Post event in Brussels on 20 March.

Over the coming months the European Council (representing the EU Member States) and the European Parliament will be hammering out a new “design” for the European electricity market, in “trilogue” negotiations with the European Commission.

In its Clean Energy Package, in particular the proposals for a revised electricity regulation and revised electricity directive, the Commission is trying to create a new regulatory structure for the EU electricity market, one that is capable of dealing with the steadily increasing amounts of renewable energy into the system. The Commission is convinced that to make this energy transition happen cost-effectively, a well-functioning internal market is key. The European Parliament mostly agrees with that vision.

“When we speak of backup, offshore wind offers great potential”

But the Member States are concerned about the effects the new energy system will have on their security of supply. To ensure that “the lights don’t go out”, they each tend to pursue their own solution, in the form of different schemes for backup capacity and “strategic reserves”. Many observers in Brussels, including many representatives of the Commission, are worried that this preoccupation with national concerns will lead to legislation that will, in the end, do little to enhance the functioning of the internal energy market, or might even make it worse.

As one Commission official complained at a recent event, “for years the Heads of State have been saying they want to see an integrated electricity market. We translated that commitment into the Clean Energy Package, but now they are trying to water it down.”

Capacity mechanisms and strategic reserves

One of the most contentious parts of the legislation relates to the conditions under which member states should be allowed to set up capacity mechanisms or strategic reserves. Through these schemes they pay generators or suppliers to keep backup capacity available to be used in case of shortages or emergencies. Many critics feel the schemes are used to subsidize incumbent generators and do not provide enough incentives for alternative, market-based solutions, such as “demand response” schemes.

To address these concerns, DG Energy has proposed certain key principles that capacity schemes should adhere to, such as technology-neutrality and a level playing field for foreign suppliers. It also demands that Member States undertake an “adequacy assessment”, including cross-border sources, on which their scheme should be based. The European Parliament to some extent supports this approach, but the Member States want to have more say over how they evaluate adequacy in their own country.

At the same the Directorate-General of Competition of the European Commission (DG Comp) has its own guidelines to ensure that capacity mechanisms do not become a form of illegal state aid. Just recently, DG Competition approved four capacity mechanisms (in Poland, Italy, France and Greece) and two strategic reserve schemes (in Belgium and Germany). However, many observers feel that DG Competition is not doing enough to ensure a level playing field. Some say there is “inconsistency” between the policies of DG Competition and DG Energy.

Jérôme Le Page, Director of European Electricity Markets at the  European Federation of Energy Traders (EFET), says he is “not convinced” by the recent decisions from DG Competition. EFET, whose goal it is to “help create a competitive, transparent, integrated energy market in the EU”, published a position paper in 2013 suggesting “design principles” that capacity mechanisms should follow. “DG Competition’s guidelines are 90% identical to ours”, says Le Page. “But how they apply them is a little bit disappointing. They are not as firm as they could have been to make sure that the spirit and letter of the principle they established are applied in practice.”

Le Page mentions the UK’s capacity market as one that is flawed. Spain’s capacity market also “violates EU competition guidelines”, notes Le Page. “But it was set up before the guidelines became law.”

Overall, says Le Page, “we see that Member States have a declining confidence in the ability of markets to deliver security of supply. We believe the market can deliver security of supply very well, but some Member States are not even trying.”

Anne-Malorie Géron, Vice-President EU Affairs at Finnish energy company Fortum, one of the largest generators in Europe, is concerned that the way capacity markets are being set up by member states “will make cross-border trade more difficult”. “Capacity markets may be needed for security of supply, but they should contribute to making the market more flexible and competitive. That is not what I am seeing today.”

Anne-Malorie Géron, Vice-President EU Affairs at Finnish  energy company Fortum, one of the largest energy producers and retailers in northern Europe, is concerned that the way capacity markets are being set up by member states “will make cross-participation of generators  difficult”. “Capacity mechanisms may be needed for security of supply, but they should not undermine markets to become more flexible and competitive.”

Simon-Erik Ollus, Chief Economist at Fortum, says there is a risk that capacity markets become a form of “central planning”. “You become dependent on the regulator’s decisions.”

According to Ollus, policymakers are underestimating developments in renewable energy and technological innovation. “They lack vision”, he says. “There already is huge flexibility in the system today. But it’s not being used. For example, there is a lot of demand side management potential, but it can’t be used because responsibilities are not clear. It is not clear who needs to optimize what.”

Simply a necessity

Andreas Schröter, Executive Vice President Central Europe & Mediterranean at the globally operating technical consultancy DNV GL, concurs with Ollus. “Relying on capacity markets is trying to be on the safe side. That’s understandable from a political perspective. But so much could be done if we let markets develop. With the use of digitalization and big data, the market will come up with cost-effective and smart solutions that we can’t even imagine today. This will also create jobs.”

He mentions offshore wind as an example. “A few years ago we thought this would be a very expensive, intermittent technology. Now we see it as an increasingly competitive, controllable, reliable technology that offers electricity the entire time. When we speak of backup, offshore wind offers great potential.”

Vincent Dufour, EU Affairs Director at French energy company EDF, stresses that the debate over capacity mechanisms should not be “black or white”. “For us”, he says, “it’s not an ideological issue. At the end of the day, policymakers are responsible for security of supply. They have to think of worst-case scenarios. At the same time we don’t want the market to be undermined.”

Dufour does have a problem with the distinction that is being made in the regulations between capacity mechanisms and strategic reserves. Germany, for example, has a strategic reserve scheme that is used when there is a crisis. But foreign players cannot participate in that. The French capacity market works very differently. It aims to avoid a crisis and allows for broad participation. “We believe strategic reserves should have the same conditions as capacity markets”, says Dufour. “They serve the same purpose.”

“We need to stop talking about carbon content in this context. It is polluting the debate on capacity mechanism and on carbon pricing”

James Matthys-Donnadieu, head of Market Development at Belgian transmission system operator (TSO), presents yet a different perspective. “For us setting up a capacity mechanism is simply a necessity”, he says.

Belgium, he explains, is committed to phasing out its nuclear power by 2025. “We did a thorough scientific study, the results of which concur with other independent studies,  in which we found that Belgium will need 3.6 GW of new capacity by 2025. That takes into account other flexibility options, such as importing power, and demand response. This capacity will not be built without a capacity market. That’s a simple reality.”

Belgium already has a strategic reserve, Matthys-Donnadieu notes, “but that is not a structural solution for us. Whatever we do, we need new capacity to ensure the lights won’t go out.”

Michael Jenner is Director Policy and Regulation at UK Power Reserve, a company that specializes in providing “flexible generation capacity” to the market. It is the largest developer of new capacity resulting from the UK capacity market and has a portfolio of over 1 GW of small-scale, local gas power generation and battery storage assets. According to Jenner, the UK capacity market serves a useful purpose. “If there was no capacity market, we would still deliver flexibility to the market”, he says, “but not as much.”

Jenner notes that the UK capacity market helps his company finance the building of new capacity by providing secure “bankable” revenues. In the UK, an asset that is successful in the capacity market auction receives the auction clearing price for 15 years. The UK regime also supports flexibility by allowing the participation of demand-response schemes as well as interconnectors. However, Jenner does believe that it can still be improved. “Right now the capacity market just delivers kilowatts. But to support intermittent renewables, what we really need are flexible kilowatts. Assets that can provided this flexibility and rapid response should be rewarded.”

Polluting the debate

Virtually every one in the energy industry is critical of the proposal in the market design legislation to include a 550 g CO2/kWh emission standard limit for capacity mechanisms. This is intended to exclude coal plants from public support, but the industry experts feel that capacity mechanisms should not be used to carry out climate policy.

“The availability of import is extremely important for us. We have plenty of interconnector capacity, but can the electrons be delivered?”

“We already have an Emissions Trading System”, says Jenner. “In the UK we also have carbon price support which is added on top of the ETS price and companies have to factor these costs into their capacity market auction bids. How do you mix that with an emissions standard?”

Le Page of EFET agrees. “We need to stop talking about carbon content in this context. It is polluting the debate on capacity mechanism and on carbon pricing.”

Extremely important

A more complex debate has arisen around proposals from the Council and the ITRE committee of the European Parliament to require transmission system operators (TSOs) to make 75% of cross-border capacity available to the market. This at first sight seems to be a rule that would be good for competition and trade, and put a brake on government intervention. But most industry experts do not see it that way.

Le Page notes that 75% is an arbitrary number that does not guarantee welfare maximisation. Besides, he adds, “it is not clear at all what it refers to. 75% of what exactly? There are differences of opinion about that.”

“In the Nordic markets we balance demand and supply without capacity markets. We accept that we are dependent on each other for our security of supply”

He points out that ACER, the agency for the cooperation of EU’s energy regulators, in 2016 already issued a decision that should ensure that TSOs do not unnecessarily remove capacity from the market. “This is a problem that is being tackled through the implementation of Third Package network codes and guidelines.”

Matthys-Donnadieu of Elia is more positive. “The availability of import is extremely important for us. We have plenty of interconnector capacity, but can the electrons be delivered? It’s true that the ACER guideline aims to solve this, but the 75% proposal, provided it is adequately defined, puts a firm number in place.”

Integration of renewable energy

Another point of discussion in the market design debate is how renewables should be treated in the energy system. In some countries they get priority in the system (“priority dispatch”). They also generally do not have balancing responsibilities. The proposals aim to abolish these advantages, though the European Parliament wants to maintain priority dispatch for small-scale and existing installations.

Again, most industry experts agree that any kind of special treatment should be phased out. “We are against priority dispatch”, says Dufour of EDF. “We don’t understand why the European Parliament wants to extend this.”

“Of course priority dispatch should be abolished”, notes Ollus of Fortum.

Finally, there is debate about price caps, which are still used by certain Member States and which current proposals would keep to some extent. These are also strongly opposed by the industry. “We need to eliminate price regulation”, says Le Page. “Policymakers don’t seem to realise that by installing price caps they will ultimately pay the price through the capacity mechanisms.”

For Le Page price regulation is just another sign that “confidence in the market is declining”. That’s a pity, he says, because “the market is working. Wholesale prices have fallen since the beginning of market liberalization in the 1990s.”

Ollus offers the Nordic market as an example for the rest of the EU. “In the Nordic markets we balance demand and supply without capacity markets. We accept that we are dependent on each other for our security of supply. That’s possible because we have well-integrated markets. This is where the EU needs to be if it wants to deliver on its 2050 goals.”

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