EMD - You can't have the cake and eat it too...

I had the distinct pleasure to participate in the workshop arranged by Copenhagen School of Energy Infrastructure #CSEI and Oxford Institute for Energy Studies #OIES on the Electricity Market Reform in the EU at the end of March. Lots of interesting perspectives and good comparisons of the developments and approaches in EU and the UK respectively.

While the initial legislative proposal from the EC in general is good, in my opinion, there are also some less than ideal parts in there. In my intervention on the workshop I took point of departure in the contradiction that the reform is generally aimed at consumer protection and generally this is to be done through offering fixed price contracts to those consumers who want this. As long as it is a free choice, it is ok. It is a bit like an insurance that we all have on our house, car and so forth. The challenge is, this is not great for the proposed introduction of renewables in the system. 

The power system will need consumer flexibility if we are to build a system based on renewables which is affordable. This means that there are strict limits to how much social politics that can be fit into the energy sector before it becomes too inflexible to deliver on the overall aim which is the green transition. So, the legislative proposals to improve demand side response is under threat from other legislative proposals in the same legislation. And this is where we get to the point about having the cake and eating it too. We need to make some choises soon.

At the same time, when talking about affordability it is important to distinguish between affordable and cheap. The green transition will not be cheap as also mentioned by the VESTAS CEO in November 2022: (https://www.bloomberg.com/news/articles/2022-11-07/wind-giant-rues-promise-that-renewable-power-could-be-free#xj4y7vzkg.) And being on fixed prices will not be cheap, as the consumer in addition to paying for energy will be paying for someone to manage risk on his/her behalf. This may well prevent a consumer from being forced to sell his/her house, but it will be more expensive on average to pay the bills. 

So now that we are likely protecting consumers by fixed prices given that it has proven politically unacceptable to have power prices in the 400-500 €/MWh range, I wonder where it leaves our ability to assess security of supply (SoS). Normally we value loss of load (VOLL) at prices in the region of 5-10000€/MWh, but if we going forward will have interventions at prices around 500€/MWh, then we need to make business cases for capacity mechanisms at 1/10 of the cost of loss of load. In that way, we essentially need a 10 times worse SoS situation to pay for the same measures as previously to make a socio economic feasible business case... Perhaps this warrants a change in approach on capacity mechanisms? 

In my intervention I focused on 3 topics going forward; two which are in the legislative but should not be, and one which is missing but should be there.

Virtual hubs and the forward market

First of all, the proposal for virtual hubs. I don’t know if this will fix the problems of the forward market. No one does! Especially since there is no impact assessment. There is surely a case for arguing that pooling of liquidity in hubs will increase liquidity, and the EC points to the Nordic market as a case to follow. However, the Nordic forward market had is peak yearly volume traded about 20 years ago and liquidity has since then dropped by a factor of 6. So it is definitely not moving in the right direction. Whether coupling a virtual hub with Zone-to-Hub transmission rights can fix this, I don't know, as this does not exist in the Nordics presently. SvK is doing some tests with auctioning of combinations of EPADs on the SE2-SE3 and SE3-SE4 bidding zone borders, where they do sell all volumes they offer, but at an average discount of about 15-17% or so, as i understand it.

Regardless, the Virtual Hub proposal does not fix two major issues. 1: There is potentially a significant shortage of players on the consumer side of the hedging contracts. If consumers are going for the short-term contracts in the future, then

suppliers will not buy long term hedging contracts. 2: If we will only build solar and wind going forward but maintain baseload and peak contracts as the only forward contract types, then we will have a problem, because these contracts do not fit the generation profiles of those asset well enough, thus the asset owners can end up adding risk rather than de-risking their position by entering into these contracts. 

So, I think these points needs to be solved before Virtual Hubs have a possibility to be successful. And this will not happen by the winter 2023/24 or 2024/25, thus it does not fit into the current amendment of the regulation. 

What would fit however is an amendment to the FCA regulation to increase the frequency to auction off transmission rights (FTR's), make it mandatory to have products 3 years out, have yearly, quarterly and monthly products and to make them financially firm, which they are not today. This is, in my mind, likely to have a more immediate effect on the possibilities to hedge for market participants and could be ready next winter. 

Transmission Access Gurantee 

I also gave the new renewable support mechanism called Transmission Acccess Gurantee (TAG) a few comment as this is a part of the legislative proposal from the EC. There are so many things wrong with it i hardly know where to start, and i will not go through all issues as this would have to be a separate article that i may write if someone requests it.

The TAG model is a classic case of cross subsidisation between transmission assets and generation assets. This is at present illegal, but that can of course be changed in legislation if cross-subsidisation suddenly is a good idea after having been frowned upon since at least the unbundling of the vertically integrated energy companies in the EU. What changing the legislation however cannot change is, that the TAG model gives some generators a competitive advantage where they can bid in the Day-ahead market at artificially low prices in order to ensure they are dispatched, knowing that if they end up setting a low price in the bidding zone they are connected to they will be subsidised up to the price level of the reference bidding zone, thus only if they manage to drag this price down as well, they will suffer a loss. This is a very handy insurance policy to have. And best of all, it is likely free from competition but just handed out for free, and all the consumers are paying for it, while no other generators have this benefit. Lastly i will just point out that the clean energy package from 2019 managed to get renewables onto normal market conditions, and the TAG model is a significant move back towards this. It cannot be said enough, if renewables are to be the majority power supplier of the future, then they cannot be subject to special conditions written into legislation. They must compete on equal terms.

The missing topic: Locational signals

Lastly, the part which is missing. Locational pricing. Off course this is not something which will work next winter; thus you can argue the EC are right to leave it out. The point I want to make is, that we need to start the preparations for this work. It is to me quite clear that the bidding zones are not well aligned with the physics of the system, and many parties are working against this happening for various reasons that they are more or less transparent with. The fact that remains is that amending the bidding zones is a process which is working less than perfectly which is gradually leading to a less efficient power system in Europe. On top of what we already see, we are likely facing the introduction of vast amounts of new consumption in the system in the form of electrolysers to produce hydrogen for sector coupling and thereby green transition of the hard to abate sectors. This can be a good thing, but it can also be the last nail in the coffin of the zonal market desing in Europe. There is a risk, that without better locational signals these new consumers will locate themselves close to their off-takers which is often where high consumption already exists and where we are often seeing shortage of generation. This will reinforce the grid constraints we already have in the grid, and it seems unlikely that TSOs will be able to build grid at a fast enough pace to keep up with these developments. We urgently need to take steps for this not to happen.

What is needed is the current reform to lay the groundwork for what is to come. Set up tasks to address the challenges we all see. We need to find out how to fix the issues we are facing and that discussion needs to happen the next 18 months so the real work can happen once a new parliament and a new commission is in place in 2025.