Is It Time For A Single Energy Market In Europe?

On the 25th of February 2015, the European Commission adopted its strategy for a European Energy Union.

The goal of a resilient Energy Union with an ambitious and challenging climate policy at its core is to give EU end-consumers a competitive, reliable, sustainable, and affordable energy market. However, with aging infrastructure, insufficiently integrated markets and uncoordinated energy policies, the end-users do not benefit from the large array of choices and lower energy prices. It is time to create a single energy market in Europe without barriers between national borders, allowing EU energy consumers to acquire their energy where the energy cost will be less expensive.

By 2030, the European Commission is aiming for a minimum of 40 percent cuts in greenhouse gas emissions, as well as a 27 percent share for renewables energy and a 27 percent improvement in energy efficiency. If successful, the power market will be heavily affected by these measures, a market that over the past five years has been evolving in three key areas:

I. An increase of renewable energy;
II. The reinforcement of the market price signal used by investors
III. New electricity market rules CACM voted in July 2015.

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Figure 1 • Capacity addition in OECD Europe by technology, 1960-2014

The year 1990 marks the beginning of the power industry restructuring in OECD Europe, with increased development of natural gas and especially of renewables. Overall, since 2000, renewables have met 62 percent of growth in capacity in OECD Europe.

Source: IEA. Re-powering markets: Market design and regulation during the transition to low-carbon power systems (EC-IEA Roundtable on electricity market design and regulation). February 18, 2016.

The two first changes have been a challenge for the power market and the third one is the response at the European level for cross-border trading.

I. An increase of renewable energy.

The competitive power markets is badly in need of decarbonizing. The rapid increase in the share of intermittent renewable power generation has introduced new challenges for the electricity market.

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Figure 2 • Expansion of renewable energy sources in Germany

The number of renewable power plants has grown exponentially over the past 14 years.

Source: Federal Ministry for Economic Affairs and Energy. Innovative technologies to mitigate climate change.

Renewable electricity operators are subject to numerous factors that may alter the time of delivery for the energy that is produced, such as weather variations, e.g. less sun or wind. As this commodity is sold in advance, enough electricity must be produced to ensure the supply to the end-users. Related: OPEC Crude Accounts For Most Of U.S. Oil Imports Rise

The increasing market share of renewable energy is a challenge for the spot market, with “flexibility” being a central concern. The share of renewable energy has created high fluctuation on the supply side, which results in high volatility in electricity prices. The markets answer to this is to use flexible power plants as CCGT (Combined Cycle Gas Turbine) that can be turned on with short notice and to implement a demand-response mechanism that helps to produce flexibility on the demand side.

As a result of the high fluctuations on the supply side, the market forces on the spot and intraday electricity markets cause more trading to occur closer to the time of consumption. In the last five years the volume traded on the spot market has increased 31 percent and last year the volume increased 6 percent.

In 2015, the electricity spot market represented 15 percent of the total wholesale market, including the exchanges and wider over-the-counter trading. In Europe the total market is 8.517 thousand TWh/year.

II. Reinforcement of the market price signal

Investors are more confident about the role of the price signal, despite the distortions caused by the massive and rapid introduction of intermittent renewable energy into the market. Investors use more and more signal price markets to make the new investments which are needed to ensure the security of the power system. The market needs scarcity prices to send the right signal price. This signal has been reinforced in the last five years, even with the increase of renewable energy that produces distortions on the market prices.

Today, wholesale electricity prices are low across all of Europe as result of three key factors: the rise of renewables, the economic downturn and overcapacity. The operators of conventional power plants are forced to put their assets offline. If a power plant sells its electricity on the market at 20€/MWh and the production cost is 30€/MWh, it will be compelled to stop its production.

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Figure 3 • Year-ahead forward market prices [€/MWh]

Long-term arrangements are still needed to make up the difference in low-carbon generation costs, and keep financing low costs for capital-intensive investments.

Source: EnergyMarketPrice/Luis Colasante

It is important that renewable energy is successfully integrated into the market. The support of these technologies came through a mechanism of “feed-in-tariff” and the result was an increase of the share of renewable energy in the production park. Five years later, the mechanism needed to evolve because the technology was mature enough to be integrated into the power market. Therefore, some European countries planned to change from a “capacity-based funding” system to a bidding system. In this system the renewable operator will be asked to support its capacity in a competitive way, and will also have extra revenues selling its electricity to the wholesale market. In the last few years, the integration of renewable energy has been dissociated from the power market. The wholesale sector is under pressure due to a competitive power market and, on the other side, the government decreasing the price of electricity for the next decade isn’t helping either.

I argue that the integration of renewable energy should be carried out in four steps:

1. Renewable operators will have to offer their electricity at a marginal cost, which is zero (0€/MWh) in the case of wind power;
2. Production should not continue when there is oversupply as indicated by negative electricity prices;
3. Renewable operators will have to share the same level of responsibility as conventional operators do for balancing;
4. The priority for dispatching rule, i.e., renewable energy must be the first energy to be used. This priority should be reconsidered, because both the feed-in tariff mechanism and the dispatching rule make it far more attractive than other kind energies, such as nuclear, natural gas and coal power plant, which have seen large investments in the last 10 years.

To optimize power systems, renewable operators will need to offer their electricity at a marginal cost, which is zero in the case of wind power, the bid can be 0€/MWh. The operators need to turn off their production when there is an oversupply, they have to take the responsibility of balancing at the same level that conventional operators do, and the priority of dispatch needs to change.

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Figure 4 • German day-ahead baseload [€/MWh]

Negatives prices appears when they are more production than consumption.

Source: EnergyMarketPrice/Luis COLASANTE

The new market design and the new support of renewable energy have to evolve to incorporate the competitive power market, minimizing the distortion of market signal.

III. New electricity market rules CACM

On July 2015, The European Commission adopted the new electricity market rules CACM (Regulation establishing a Guideline on Capacity Allocation and Congestion Management) with an ambitious and challenging target in order to have a single European power market.

The new regulation creates a comprehensive legal framework for electricity trading in Europe and makes “market coupling” legally binding across the European market. Coupling essentially brings all bids and offers from different national power exchanges for cross-border trading into one basket (electronic platform) and allows them to operate in an optimal manner across borders, matching capacity managed by the transmission system operator (TSO) of sold and purchased volumes of electricity on the Day-Ahead and intraday power exchanges.

Market coupling is estimated to save European customers between €2.5 and €4 billion per year. The regulation will help to increase the trading of electricity over a shorter period. This will allow more efficient integration of renewables into the grid, while suppliers and traders can take into account better forecasts on how much solar or wind energy will be produced. The European’s Commission new decision-making procedure, which enables effective regional cooperation among grid operators, power exchanges and regulators, allows a «legal framework for electricity trading in Europe».

Until now, I have described the way the power market has evolved. However, it is important to highlight some of the regulatory and market constraints faced by the power trading sector.

Not all European countries have the same flexibility issues. Germany, being a pioneer in the development and implementation of renewable energies, requires a more flexible regulation framework, whereas other countries; such as France, Belgium, UK, Spain or Ireland, which are more concerned with spike consumption in the winter period. These countries have put into place capacity mechanisms, but each one in a different way. Related: Could The Bottom Fall Out Of This Oil Rally?

In France the mechanism is decentralized. This means that each electricity supplier has the obligation to justify that it has enough production capacity to survive in the spike consumption period of their costumers’ portfolio. In the UK on the other hand, the mechanism is centralized. It is the TSOs that have the obligation to insure capacity for the spike hours.

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Figure 5 • Neighboring capacity markets in selected countries of Western Europe

Lack of coordinated European capacity mechanisms

Source: IEA. Re-powering markets: Market design and regulation during the transition to low-carbon power systems (EC-IEA Roundtable on electricity market design and regulation). February 18, 2016.

Another difference is the type of support for each MW installed and available. There is a large price difference between each country. For instance, in Spain the MW can be remunerated around 20,000 €/MW, in Ireland around 70,000 €/MW and in Greece 90,000 €/MW.

The average fixed cost of O&M (Operation & Maintenance Services ) for an efficiency CCGT is around 20,000 €/MW and the total fixed cost is around 120,000 €/MW. It means in some countries more than 50 percent of the fixed cost is covered by the capacity mechanism.

On the one hand, the European Commission wants to have a single power market, while on the other hand, each European country is putting in place different policies of capacity mechanisms. These different polices will create more distortion in the market price signal.

If there’s confidence in the market price signal, the capacity mechanism will no longer be needed and it would be rather redundant. However, if a country decides to implement this mechanism, the end-users will be hit hardest as a result of the price increase. This mechanism should be a transitory measure, while the energy transition is achieved.

Paradoxically, there is a will at the European level to encourage the use of new technologies, but it seems hard enough to let go old ones.

The security of supply is also an important issue that Europe follows very closely. Europe plays an extraordinary and ever-growing role to ensure the security of supply. The safer the cross-border trading is, the better the provision of power will be, guaranteeing the security of supply.

A major advantage for Europe is the fact that the maximum demand for power for all countries never occurs at the same time; therefore, at any given time, power can be provided to or received from neighboring countries. A cross-border agreement will make a decisive contribution to satisfy energy demand.

Europe needs to continue to invest in the expansion of its grid. One of the main obstacles is that the local population in the affected areas do not welcome this expansion. All players on the market have to act towards the new energy design. This can only be done with a successful expansion of the grid. The expansion of the grid wouldn’t only have a positive impact in balancing and smoothing the price, but it would also lower C02 emissions, as the energy will be sent from where it is abundant to where it is needed.

Since the European internal market is growing in all countries, individual markets within each state are no longer isolated. Therefore, there will be greater opportunities if market coupling is abided by all countries from Portugal to Finland, increasing the efficiency of the market and the derivatives contracts. However, a single power market requires a common essential understanding and coordination regarding the market design. This subject needs to be addressed at the European level because, at present, there are different approaches to a future market design. The most effective design would be a customized model for all the countries in a common single market, rather than to find individual answers within each country.

By Luis Colasante for Oilprice.com

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