Preserve, Repair or Rebuild?

A discussion of proposed reform options for the European electricity market

New policy paper by the Austrian Energy Agency on behalf of the BMK

The rise in fuel prices since summer 2021 - affecting natural gas and many of its substitutes - has also made electricity generation in Europe much more expensive. This trend intensified significantly in the wake of the Russian war of aggression against Ukraine and the resulting concerns about security of supply from the following February. The temporary peak of price developments on the short-term wholesale market was in August 2022. After a brief easing in early autumn 2022 and a renewed rise at the end of the year, the price of electricity has stabilized since the beginning of 2023, but like the price of gas, it is still more than double the long-term average.

The call for a long-term reform of the electricity market led to a high-profile speech by Commission President Ursula von der Leyen in the European Parliament in June 2022 and subsequently to the launch of an EU reform process to change the design of the European electricity market.

"Gas is the most expensive, and it determines the entire electricity price. This market system no longer works. We need to reform it. We need to adapt it to the new realities of the dominant renewable energies. That is the task that the Commission has now taken on. It is not trivial. It is a huge reform. It will take time. It must be well thought through. But we must take a step forward to adapt our electricity market to modern conditions."

On March 14, 2023, Energy Commissioner Kadri Simson presented the European Commission's proposal on how this reform should be structured based on the relevant directives and regulations. The Austrian Energy Agency classifies these proposals in this new paper commissioned by the Federal Ministry for Climate Action, Environment, Energy, Mobility, Innovation and Technology and discusses the effects and the need for further reforms.

Different perspectives on the current state of the European electricity market dominate the debate

The general public debate on reform options for the electricity market design reflects views for and against short-term intervention options, long-term adjustments and the desire to maintain functioning market components.

In principle, three different desired degrees of intensity of market adjustments can be distinguished in the current debate.

1. Rebuild: a more fundamental reform or redesign of the underlying market segments

2. Repair: the repair and adjustment of the current electricity market design, e.g. by adding new instruments

3. Preserve: the avoidance of extensive changes to the existing electricity market design with minor corrections at most

The positions on these three degrees of reform intensity have diverged widely between different economists and EU member states in recent months. Different problems and interests have emerged in different countries. Accordingly, a large number of different - often divergent - ideas for solutions have also flowed into the European negotiation process. The search for a consistent set of market design options for different issues is complex. This complexity is also reflected in the European Commission's proposal to reform the electricity market design.

The European Commission's draft reform contains measures with varying degrees of intensity.

Some areas of action can be identified in which the currently proposed electricity market reform would already actively bring about long-term changes in the dynamics of the energy markets. This includes, in particular, the reform of the support system for renewable energies with the help of contracts for differences (CfDs). The proposal envisages integrating new plants into the energy system on a full-cost basis in the long term and at the same time reimbursing electricity customers for part of the added value generated by these plants. The planned introduction of regional virtual hubs could also be an influential instrument. The establishment of virtual regional hubs should simplify long-term trading between several price zones so that cross-border lead markets with higher liquidity and therefore more meaningful prices can develop.

 

Achievement of further goals: Establishing consumer rights yes, increasing market accessibility and transparency rather no

The reform aims to create new opportunities for consumers that did not previously exist in all member states. These include the right to "energy sharing", the right to a supplier of last resort, the right to fixed-price tariffs, the right to multiple electricity contracts and metering points, as well as the prevention of electricity disconnections for vulnerable customers.

While the reform focuses on Power Purchase Agreements (PPAs) as a risk management instrument, the accessibility of these procurement contracts for smaller industrial or commercial energy customers and households remains low. Simplified access to the wholesale market for smaller market participants could be advantageous in terms of increasing liquidity and the informative value of wholesale results. However, the reform proposal does not provide any concrete starting points for this. Europe-wide grid cost equalization, e.g. for electricity transit regions and regions with above-average renewable expansion, as well as simplified access to compensation funds for renewable and grid expansion for affected citizens would also be a helpful instrument for reducing resistance to necessary expansion projects.

Further reform approaches for the renewable-dominated energy world after 2030 should be developed quickly.

In the medium term, further reform steps should be taken to ensure that the design of the electricity market meets the requirements of an electricity system based entirely on fossil-free - mainly renewable - generation in the long term. To this end, more suitable approaches should be found to better integrate capital costs into the remuneration of new investments. The current energy price crisis has also taught us something about the acceptance and effects of high price phases: A continued focus solely on price signals from the energy-only market to finance new investments in flexibility should be critically questioned. In normal times, these price signals were not sufficient to incentivize investments - and led to enormous distortions in political interventions during high price phases.

The discussion and decision-making process for the market design after 2030 must be started now in view of the lengthy implementation of structural reforms - because no market can function well in the long term if the regulatory future is unknown.
 

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