In the past year, electricity prices have broken record after record across Europe. Inflation, the war in Ukraine and a historic gas supply crunch have played a role in this harsh reality. What solutions are at hand to help Europe emerge from this crisis with a stronger and more sustainable economy? Can the electricity market design be rewritten to both protect customers from price volatility and attract the massive investments needed to reach net-zero?
Even though most interventions and measures adopted across the continent have been focused on electricity prices, the current price distress is the result of a gas supply crisis, not a market design crisis.
For decades, the current market has enabled the short-term optimisation of the power system, by prioritising the dispatch of the cheapest and most efficient energy sources, such as renewables and nuclear, before turning to more emitting sources.
This design has enabled clear price signals to spur investment in renewable sources and has ensured cross-border trade between countries, thereby reinforcing the EU internal market and the EU’s security of supply.
Europe has the largest synchronous electricity grid in the world connecting
across 24 European countries
1. Efficient dispatch – allowing to harness the low variable cost of renewables
2. Clear price signals – enabling trade for thousands of generators, prosumers, flexibility providers
3. More interconnections – leading to lower prices and strengthened security of supply
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Yet, the current energy crisis, triggered by Russia’s induced gas crunch, prevented consumers from benefitting from renewables’ low prices, as record-high natural gas became the price setter. This called for the need to mitigate the impact of short-term markets on the price of electricity paid by consumers.
Since European Commission President Ursula Von der Leyen called for a reform of the EU electricity market, several Member States have made headlines with their own reform proposals. From the radical Spanish and French non-papers to the more conservative joint letter from Germany and six other Member States, the debate has reached the highest levels of EU policymaking.
As detailed in Eurelectric’s response to the Commission’s consultation, the fundamentals of the electricity market must be preserved. Marginal pricing and integration across national markets are the best way to ensure that power system assets are used as efficiently as possible across the continent.
Reducing households and businesses’ exposure to price volatility is not the only challenge the new reform must tackle.
Investment levels in the power sector today are insufficient to deliver net-zero by 2050. If nothing is done to reassure investors, Europe’s decarbonisation progress will risk years of delay. Market design rules must preserve, and even boost, investors’ appetite for clean and renewable electricity generation, distribution grids, storage, flexibility solutions and, ultimately, the electrification of the economy.
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The current market design needs to be upgraded to meet the investment challenge and support an efficient transition towards net-zero in the next decade. The key gaps in the current market design can be classified in three main categories:
Forward hedging as well as power purchasing agreements (PPAs) and contract for difference (CfDs) all have a role to play.
These instruments would allow consumers to negotiate a fixed price for part of their energy demand thus avoiding excessive exposure to short-term market prices. At the same time, these contracts can reassure investors by providing price stability and long-term visibility on returns and encourage them to reinvest in renewable generation or additional storage and flexible capacity.
A market design fit for the net zero must build on the current market and add on three pillars meant to better protect customers, boost investment and better assess capacity needs. It would look as follows:
An enhanced and liquid long-term contracting framework is key to meet generators and consumers’ needs. Diverse products including contracts for 2-4 and even up to 10-15 years or longer will smooth out price risks for both sides and allow consumers to receive the benefits from less volatile energy costs.
The investment challenge requires a stronger framework. The objective is to foster timely investment and reduce financing costs in order to meet decarbonisation objectives while maintaining high standards of security of supply, ensure affordability, reduce dependence and address system needs.
The fast decarbonisation of the electricity system raises new challenges for its safe operation. Flexibility sources and firm power will need to expand to accompany renewables, taking advantage of the new opportunities that will emerge from the electrification of transport, industry and buildings.