No to the Spanish Proposal - Yes to a Market Design Fit for Net Zero

This week, the European Commission launched the long-awaited consultation on Europe’s wholesale electricity market reform. The consultation , launched on 23 January, will be open for a short period until 13 February. Stakeholders are now encouraged to respond on questions concerning the reform proposed by Commission President Ursula von der Leyen in her EU State of the Union speech back in September, due to mounting pressure from the energy crisis. Such reform will toe a fine line. On the one hand, it is valid to say that we need a market that signals the benefits of the energy transition. On the other, mishandling could destroy investor confidence right when we need to be ramping up investments across the sector.

The energy weapon

Last year, 2022, we entered an entirely new era for European energy procurement. The Russian invasion of Ukraine sent shockwaves across the continent, and indeed, across the world. How it manifested itself here was instability in gas markets leading to an exploding cost of electricity. But why?

Briefly, our dependence on fossil fuels sourced from Russia for electricity generation was an addiction with severe withdrawal symptoms. As the EU levied sanctions against Putin’s rogue regime, his retaliation was to let our supply of gas dry up. This, among other factors, sent the price on a skyward trajectory. Since gas is used to generate electricity, its price helps set the price of electricity in what we call the “merit order”.

Under the merit order market structure, the source of energy that generates the last, most expensive, unit of electricity to meet demand sets the price. This source is often gas and that means that the price of electricity is highly exposed to the volatility of gas. That is why with winter approaching – when Europeans would turn to their gas boilers for warmth – the Commission faced political pressure to ensure the rising demand didn’t inflate the cost of electricity anymore. Hence, the proposed market reform.

Since the proposal surfaced, there has been a lot of fog lingering over what the reform will entail. This played out quite literally with the much elusive and long-delayed consultation which seemed would never be launched. Now, with input coming in from stakeholders, we would like to take the time to reiterate what Eurelectric has been saying about the reform; what needs to be done, and what does not.

Don’t throw the baby out with the bathwater

First and foremost, Eurelectric fully supports the current market structure. The market is performing exactly as expected in these circumstances, which the EU Agency for the Cooperation of Energy Regulators (ACER) , concluded in their Final Assessment of the EU Wholesale Electricity Market Design early last year. Commission Executive Vice President Frans Timmermans echoed this , saying “It took 30 years to design this market. Let’s make sure we don’t throw out the baby with the bathwater when we change it”.

It is indeed not the time to throw away what we have. The European Internal Energy Market (IEM) has delivered roughly €34 billion in welfare benefits to customers annually, according to ACER’s assessment. What we face today is an energy crisis, and, as our Secretary-General, Kristian Ruby told Alex Janiaud from the Financial Times ’s Sustainable Views in a recent interview , a crisis is always a tricky moment to make a structural reform. It often begs the question as to whether you are looking to address immediate crisis symptoms with the intervention or trying to fix something structurally for the next 20 to 30 years.

With this in mind, there exist ways in which we can improve the market structure for the coming decades. In December, we released our position paper on A Market Design Fit for Net Zero . What we see is a foundational market structure that has and does work well, but that can still benefit from modernisation to reflect the changing needs as the energy transition steams ahead. In the words of our acting President, Leo Birnbaum from E.ON , “The liberalisation of the power sector has served Europe well and is today a guarantor of security of supply and solidarity. Looking ahead, we should continue to develop and complete the market rules to ensure that they are fit for purpose in the future as well.”

This development and completion that he mentions come in the form of three add-ons:

• A consumer add-on that delivers the benefits of the energy transition to consumers and fosters their engagement in the transition
• An investment add-on that provides proper investment signals to investors while preserving competition
• An adequacy add-on that maintains security of supply and that meets evolving power system requirements for firm and flexible capacity

There are alternative approaches for market design based on the market principles and countries will have different preferences depending on their local specificities. Overall, however, priority must be given to the preservation of the IEM. There are proposals that have been made, that unfortunately, do not set this priority and risk upending the market.

No to the Spanish proposal

Of notable worry amongst the market reform chatter is Spain’s recent non-paper “Proposal to reform the EU’s wholesale power market” . In an eloquent rebuttal to the proposal, we published a letter yesterday acknowledging the positive points of the proposal such as the need for well-designed capacity markets and the use of auctions for new renewable generation. However, there remain 5 major flaws that cannot go unnamed. The Spanish proposal risks:

• Increasing costs and prices by eliminating the market and competition
• Fragmenting the IEM
• Increasing regulatory risk for new investments in renewable generation
• Discouraging the use of power purchasing agreements (PPA)s and removing the demand signal from marginal pricing
• Introducing regulated prices for hydropower and nuclear generation thereby disincentivising flexibility services

To summarise, taking existing assets and forcing them into contracts for difference (CfD) would simply be a retroactive change that will deter only investors and have negative impacts on the energy system in parallel. Expanding CfDs would also crowd out PPAs that are often used to support renewable energy producers. Therefore, this proposal will only do a disservice to European energy independence and the energy transition. The market is a structure that provides valuable information for investors. If we simply toss everything together as one, it destroys the signal the investor is supposed to get from each investible project. Such a complex mechanism requires much more nuance.

Coming up

The market reform discussion is far from over. In the coming months, politicians will gruel over how to best proceed. We would like to call on them to proceed with caution and heed the warnings. We still lack a proper impact assessment, and the timeline is much too swift for due diligent implementation. Before moving forward, it is highly advisable to take in as much information as possible on the topic. And we see that happening. With the likes of Energy Commissioner, Kadri Simson, joining our upcoming event on #MarketDesign , it shows that the top echelons in the institutions are still searching for the best solutions. We strive to ensure, then, that harmful proposals like the Spanish one, do not anchor the debate.