Consultation Open for Re-Design of EU's Power Market

On January 26, the European Commission ("EC") launched a consultation resulting from the ongoing discussions around the reform of the European Union's ("EU") electricity market. Cracks in the market design became visible after a drastic reduction in the importation of Russian gas, prompting a re-assessment of the structural shortcomings of the market. This consultation primarily addresses public authorities, national regulators, representatives of ministries, Distribution System Operators, Transmission System Operators, companies that conduct business in the energy sector as well as consumers (both industrial and household). The consultation period concludes on 13 February 2023.

Though renewables form a growing portion of the EU's energy mix, a significant amount of electricity continues to be generated by gas fired power plants. Due to the increase in gas prices, electricity has become significantly more expensive, and consumers have had to endure high energy costs for a prolonged period. Policy instruments to protect consumers have also proved to be quite limited.

Along with high gas prices, the high fluctuation of gas supply has created an energy security crisis, which the EU has sought to remedy by diversifying its gas supply network and accelerating the rollout of renewable energy.

This effort was the core of the REPowerEU plan which, along with the above, took measures such as implementing price limiting regimes to avoid windfall profits, reduction of demands for electricity and gas, and building a strong gas storage regime. The re-design of the power market is another tool to aid EU in its mission of being self-sufficient on the energy front, while also enabling the objectives of the European Green Deal – including its aim of being climate neutral by 2050. The key focal points of the consultation have been captured below.

Establishing independence from short term fossil fuel costs

As per the EC, a strong focus of the market re-design exercise is short term markets, which continue to be strongly influenced by fluctuating gas prices. The present regulatory focus has been on long-term instruments, an approach that has failed to protect large, small and medium size industrial consumers as well as households in a crisis context.

On the other hand, renewable power generators have benefited from surplus profits, since (a) their production costs are generally low but short-term market prices have been high; and (b) their minimum profitability is often protected by policy.

Short term markets remain important for the integration of renewable power, so that the consumer has the cheapest form of electricity available at any given point in time. Hence, there is a requirement to complement the regulatory framework governing these markets with instruments that would create incentives for the use of long-term contracts.

Such long-term contracts would ensure that the consumers and suppliers are more immune to fluctuation of prices in short term markets, and thus remain stable for a longer period of time. These reforms would essentially create a "buffer" between the short-term markets and the consumer.

The EC has decided to focus on two key long-term arrangements: Power Purchase Agreements ("PPAs") and two-way Contracts for Difference ("CfDs").

• Using PPAs: The EC is aiming to incentivise the increased take up of PPAs in the new future market, especially by small and medium size industrial consumers through promotion via public tendering for renewable energy. Credit guarantees for such PPAs could be possibly backed by public actors.
• Using CfDs: The other measure under consideration is the use of two-way CfDs, which are also less dependent on short term markets. The income of the selected generators provides other companies with an incentive to invest, while the competitive tendering process for such contracts ensures that the cost to the consumer remains low. The EC will be considering the extent to which the use of CfDs can be made mandatory for investments that require public support, and if the use of these contracts would only cover only new generation assets. The use of PPAs will be given primacy over CfDs.

Driving Investments into Renewables and Dealing with Long Term Challenges

The consultation expresses that the increase of deployment of renewable energy is critical for EU's secure supply of low carbon energy. The EC is planning to focus on increasing this deployment in the heating, cooling and transport sectors.

However, as this deployment increases, the EC also foresees solving long term challenges by (a) sustaining investment in weather independent low-carbon energies – not only in their generation but also in storage and other flexibility tools; and (b) creating stronger locational price signals to ensure that investments are made where needed; this would reflect the physical reality of the electricity grid.

The EC is also looking to incentivise investments in grid capacity and interconnectivity between Member States.

Balancing the Electricity System

The consultation also addresses methods to improve flexibility solutions like energy storage, demand response, and development of weather independent low carbon sources. This also includes measures such as adapting the tariff design of system operators, and deploying targeted instruments to improve efficiency of short term markets – focussing on intraday markets.

Learning Lessons from Interventions in the Short-Term Markets

The EC acknowledges that the energy crisis led to several ad hoc regulatory actions in the recent past, especially surrounding control of electricity prices. This further created a level of uncertainty regarding the future regulation of the market, which the EC is seeking to dispel. The consultation thus seeks stakeholder feedback on whether certain aspects of these emergency actions should be concretised as structural features of the new energy market which may be activated in future crisis situations.

Protecting Consumers

The EC believes that energy efficiency for consumers can be achieved through providing innovative measures to gauge demand response. One of those measures is to digitalise the energy system to enable active participation of consumers – which would, for instance, permit consumers to not use grid electricity at the most expensive times of the day. Other targeted improvements mooted by the consultation include permitting consumers to share energy to control costs.

Consumers should be able to benefit from PPAs entered into between the generators of renewable power and their suppliers. Further, to avoid situations where consumers must pick up costs if supplies fail, the EC may require supplies to be hedged adequately, combining it with the Supplier of Last Resort regime.

The EC is also considering enabling Member States to guarantee SMEs and households access to a minimum necessary amount of electricity at an affordable price in crisis situations.

Robust application of the REMIT

Considering the very high price volatility caused by the interference of external actors, the EC recognised that there might be a risk that entities engage in illegal wholesale trading practices. To combat this, it intends to ensure that Regulation (EU) 1227/2011 on wholesale market integrity and transparency (REMIT) is up to date and functioning well.

Once stakeholder engagement is received, the EC intends to present proposals for amending the electricity market design in March 2023.

The Consultation can be found here.

If you would like to understand what this proposal and consultation means for you or your business, or to learn about making a submission, please do not hesitate to get in touch.