On 14 March 2023, the European Commission (“Commission”) published its legislative proposals to reform the EU electricity market in a two-fold way:
We reviewed the REMIT Proposals in a previous Law-Now (here) and now turn to the Market Reform Proposal.
The proposal aims to address consumer, industry, and investor concerns over exposure to volatile short-term fossil fuel prices by optimising electricity market design and emphasising longer-term instruments such as PPAs, CfDs, forward contracts and flexibility schemes. At the same time, the Commission is seeking to bring marginal improvements to short-term markets, boost non-fossil flexibility solutions, and strengthen consumer protections. We explore each of these themes further in this Law-Now.
A. REDUCING EXPOSURE TO VOLATILE SHORT-TERM PRICES
A key objective of the Market Reform Proposal is to decrease consumer exposure to short-term electricity markets, which are driven by volatile and recently record-high prices of fossil fuels (principally natural gas). Conversely, the proposal also aims to harness the benefits of the low operating costs of renewables and reflect these in consumers’ bills to a greater extent.
Readers will no doubt be familiar with speculation that the Commission could seek to reform the marginal pricing model and therefore decouple short-term electricity prices from natural gas and other fossil fuels. The Commission, however, ultimately concluded that the short-term marginal pricing model delivers valuable price signals and should be preserved, particularly given the lack of viable alternatives.
Instead, the Commission aims to reduce price volatility and pass-through to consumers the benefits of cheaper renewables by enhancing the role of long-term markets and contracts. Specifically, the Commission proposes to:
- Develop the PPA market – support the development of long-term Power Purchase Agreement (“PPA”) markets, which can protect both developers and consumers from price volatility.
- Changes to the design of CfDs – encourage Member States to implement two-way Contracts-for-Difference (“CfDs”) schemes, thus bringing price stability to consumers and supporting renewables and other low-carbon generators.
- Improve forward markets – improve the functioning of the forward market (i.e. up to 3 years ahead) to create deeper and more liquid hedging opportunities, and also incentivise the development of fixed-price contracts.
- Allow consumers to contract with renewables – enable consumers to contract directly with renewable energy sources through energy sharing schemes.
In the following sub-sections we explore some of the key features for each of these proposals.
Developing the PPA market
Building on existing EU legislation and guidance aimed at promoting PPAs (particularly RED II and REPowerEU), the Commission proposes to amend the Electricity Regulation such that:
- Reduce off-taker credit risk – Member States should ensure that financial instruments (including guarantee schemes) are available to smaller companies that are not in financial difficulty to mitigate against the risk of off-taker default, which is perceived as an entry barrier to the PPA market for such entities. It remains to be seen whether favouring less creditworthy off-takers might have unintended consequences on the PPA market, where currently credit risk is a key driver in procurement and negotiations.
- Ensure compatibility with public support schemes – Member States should also ensure that public support tenders allow generators to reserve part of the project’s capacity for a market-based revenue stream under PPAs. There is also the proposal to include evaluation criteria in public tenders to incentivise access to PPA markets for customers that face entry barriers to that market (e.g. SMEs). This means that the Commission considers that a project can have access to both CfDs and PPAs, which so far have been mutually exclusive in some EU Member States.
- Mandatory supplier hedging – the mandatory hedging provisions being inserted into the Electricity Directive (explained further below) are also expected to boost the PPA market, given that these provisions specifically refer to using PPAs to reduce exposure to price volatility.
Changes to CfDs design
The Commission’s proposal also seeks to clarify existing provisions (predominantly in RED II) regarding the permitted design of publicly supported schemes for new investments in low-carbon electricity generation projects.
This is proposed to be achieved by way of inserting new provisions in the Electricity Regulation, which provide that:
- Two-way CfDs only – publicly supported schemes must now take the form of a two-way CfD. Specifically, this means that a generator benefitting from a CfD will: (i) receive top-up revenue when the market reference price is below a pre-agreed strike price, or (ii) return to consumers revenue when the market reference price is above the pre-agreed strike price.
- Within-scope technologies – the obligation to use two-way CfDs applies to new investments (including repowering and investments aimed at extending existing generators or prolonging their lifetimes) for wind, solar, geothermal, hydropower without reservoir, and nuclear energy.
Improving Forward Markets
Responding to persistently low liquidity and other issues such as short timeframes, the Commission wishes to improve forward markets (and therefore market participants’ ability to hedge their longer-term positions) through the following measures:
- Creation of Virtual Hubs – building on experience in the Nordic market, ENTSO-E will be required to submit proposals for the establishment of virtual hubs for the forward market. A virtual hub would bring together all the bids and offers for forward electricity products in a particular region, which would increase the number trades (i.e. improve liquidity) and create a single reference price for several countries.
- Certainty on Transmission Rights – to provide market participants with certainty on their exposure to potential congestion between bidding zones, TSOs will also be required to offer financial transmission rights for up to at least three years ahead.
Enabling energy sharing
To assist households and SMEs who are unable to develop behind-the-meter generation (and therefore unable to deduct off-site generation from their metered consumption), the Commission is proposing to introduce an energy sharing framework. Under this framework active consumers can self-consume renewable energy generated or stored offsite either from facilities they own, lease, rent or which has been transferred to them by another active consumer.
In essence, this will allow any bill-payer to have the right to have injected electricity (from offsite generation) deducted from their metered consumption for the purpose of calculating the energy component of their energy bill (but without prejudice to taxes and network charges).
B. IMPROVING THE EFFICIENCY OF SHORT-TERM MARKETS
While the Commission is no longer contemplating changes to the marginal pricing model for short-term markets, it does nonetheless consider that certain improvements could be made to make these more liquid and create a level playing field for market participants.
Some of the Commission’s key proposals for achieving these aims are as follows:
- Shorten intra-day gate closure time – renewable generators are less able to participate in markets with shorter timeframes (intra-day, day-ahead and balancing) given their non-dispatchable nature. To address this issue and enable greater participation by renewable generators in shorter timeframes, the Commission is proposing to set the cross-border intra-day gate closure time closer to real time. Cross-border intra-day gate closure is currently 1 hour before real time, and the Electricity Regulation is proposed to be amended for this to be at most 30 minutes before real-time by 1 January 2028.
- More granular short-term products – there is also the proposal to introduce more granular products for trading in day-ahead and intra-day markets (i.e. with minimum bid sizes of 100kW or less). This is intended to allow for the effective participation of demand-side response, energy storage and small-scale renewables including direct participation by customers.
C. INCENTIVISING NON-FOSSIL FLEXIBILITY SERVICES
Given increasing volumes of intermittent generation and irregular consumption patterns, there remains a pressing need for flexibility solutions. Moreover, the recent energy crisis exposed the dominance of fossil fuel generators in the flexibility market, which compounded the spike in energy prices across the continent.
While the Clean Energy Package (among other guidance/proposals) made provision for facilitating the deployment of non-fossil fuel flexibility providers, such as demand response and storage services, the Commission notes that national transposition and implementation is lagging behind across most of the EU. Accordingly, the Commission is now bringing forward additional measures which it hopes will further boost the flexibility market, as follows:
- Network tariff design – Article 18 of the Electricity Regulation, which governs how network tariffs/charges are set by National Regulatory Authorities, is being amended to expressly incentivise system operators to develop innovative solutions to optimise existing grids and procure further flexibility services. Notably, there is now express reference to the anticipatory investments in the context of tariff setting – suggesting that anticipatory investments may become more acceptable to regulators when setting price controls, albeit the drafting is not very clear in this respect.
- Formalising sub-meters – certain sites may have significant behind-the-meter activities behind a single connection point (e.g. solar PV co-located with storage, demand with on-site generation, etc.) which are currently difficult to integrate into the wider system as discrete services. The Commission therefore proposes to allow system operators to use sub-meter data (including from private sub-meters) for settlement and observability processes of demand response and flexibility services to support the development of these services and facilitate the participation of prosumers in electricity markets (particularly in EU Member States where the roll-out of smart meters is slow or where smart meters do not provide sufficient granularity).
- Indicative targets for demand side response and storage – national regulatory authorities will be required under the Electricity Regulation to set a national objective for non-fossil flexibility such as demand response and storage, which will be based on a periodic assessment (using an ACER-issued methodology) on each system’s need for flexibility services.
- Capacity mechanism for low carbon flexibility providers – the Commission is proposing to amend the Electricity Regulation to promote the participation of low-carbon flexibility providers in capacity mechanisms (i.e. by setting a low CO2 cap and adding flexibility requirements). In addition, where existing mechanisms are insufficient to promote non-fossil flexibility, the Electricity Regulation will expressly permit the creation of non-fossil flexibility support schemes based on additional capacity payments to demand side response and storage providers, noting that such schemes must use a competitive bidding process.
- “Peak shaving” products – the Commission also proposes to allow system operators to develop a “peak shaving” product, to incentivise consumption reduction at peak time (i.e. at times of high demand for electricity and/or limited generation from renewables).
D. BETTER CONSUMER PROTECTION AND EMPOWERMENT
The Commission is also using this opportunity to set out a range of measures aimed at protecting and empowering consumers in the retail market. Some of the key proposals, which will be reflected mainly in the Electricity Directive, are as follows:
- Fixed price contracts – to increase certainty and protections for consumers, the Commission is proposing to clarify that fixed price contracts cannot be unilaterally modified. There will also be an express obligation for suppliers serving more than 200,000 customers to offer fixed-price contracts for at least 1 year, and at least one fixed price contract will need to be available in all Member States. However, there is no provision on pricing for fixed price contracts, meaning that suppliers will be able to price these as they see fit.
- Mandatory risk management – the Commission is proposing to oblige all suppliers to have in place appropriate hedging strategies to mitigate against the risk of wholesale price volatility. While each Member State will be responsible for assessing supplier hedging strategies, the Electricity Directive will provide that such strategies may include the use of PPAs and that Member States may specify a minimum share of suppliers’ exposure that must be covered by PPAs with renewable energy sources.
- Regulated pricing derogation – it is proposed that Member States may carry out price interventions to protect households and SMEs, including to set prices below cost for a limited volume of consumption (i.e. 80% of the median consumption for households and 70% of historical consumption for SMEs) and for a limited time. The Commission would be responsible for evaluating whether an emergency has indeed arisen, based on pre-set criteria. These criteria largely emulate existing ones in the emergency measures set out in Council Regulation (EU) 2022/1854 (analysed here), which briefly are:
a. Very high prices in wholesale electricity markets at least two and a half times the average price during the previous five
years occur which are expected to continue for at least 6 months;
b. Sharp increases in electricity retail prices of at least 70% occur which are expected to continue for at least 6 months;
c. The wider economy is being negatively affected by the increases in electricity prices.
- Multiple suppliers at a premises – the Commission is proposing to amend the Electricity Directive to make clear that customers may have more than one meter installed at their premises (i.e. sub-meters, which may be separately billed and deducted from the main metering). This will also enable customers to conclude contracts with more than one supplier for a single premises.
E. Limiting windfall revenues for inframarginal producers
Renewables investors will be pleased to learn that the Commission has decided not to embed the inframarginal revenue cap (or similar measures) as a permanent feature of market design. The cap was designed to limit windfall revenues for certain (essentially non-gas) generators and was introduced in the set of temporary emergency measures permitted under Council Regulation 2022/1854.
The Commission does note, however, that it will continue to monitor the effect of inframarginal revenue cap measures after the second reporting date (set on 30 April 2023) and decide on the potential prolongation of the cap beyond 30 June 2023.
The proposed reform intends to capture lessons-learnt from the recent energy crisis and increase the resilience of the market to price shocks. As such, it is closer to evolution, as opposed to revolution, of the EU’s market design rules.
Affordability is the new buzzword that appears in EU policy documents indicating that the Commission is now more attuned not only to the need to ensure that energy in Europe is green, but also affordable for consumers and businesses. On 20 March 2023, ACER published an inventory of 400+ emergency measures Member States adopted during the energy crisis to deal with high prices. The high number of measures across Europe is a tell-tale sign of a fragmented approach to a largely common problem, i.e. high prices.
Different needs in different parts of Europe may have been the underlying cause for this idiosyncratic approach. Nevertheless, the Commission’s interventions during this time proved unsuccessful in harmonising the response among Member States.
There is also the legacy issue of lagging transposition of the Clean Energy Package, which the Commission is now seeking to circumvent by enshrining many of these latest reforms in the directly applicable Electricity Regulation. This does not, however, fully remove the issue of delayed transposition at national level, because several key reforms require a degree of implementation across EU institutions and Member States.
More fundamentally, it remains to be seen whether the renewed focus on shoring up long-term markets and PPAs will have the desired effect and not give rise to unintended outcomes. A whole host of existing electricity market arrangements and processes rely extensively on spot markets – it may therefore be that the prescribed remedy could be worse than the perceived disease, particularly where short-term market liquidity is sacrificed for other (largely untested) purposes.
Unsurprisingly then, some market participants (notably as ENTSO-E) have already voiced concerns regarding the Market Reform Proposals, specifically that some of them fall short of expectations, while others may potentially distort market functioning, system security and costs borne by consumers.
There is of course time for the proposals to be further refined and improved, given that the Market Reform Proposal will be adopted through the ordinary legislative procedure (meaning it is subject to legislative review by the European Parliament and the Council before entering into force). This is likely to take approximately 12 months, during which further amendments could be proposed.