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The composite portrait of a new electricity market model

Proponents of the liberalized electricity market have a good chance of opposing its reform by explaining to those around them that the crazy and volatile prices observed are only due to the crisis on fossil fuels: oil and gas too expensive and, in Europe, Russia as the primary cause of this chaos. Should we then put everything on the ground because the market has also brought benefits (encouraging investment in renewables, security of supply between Member States, etc.)?

As a working paper from the Florence School of Regulation (FSR) clearly explains, when the electricity market was liberalized 25 years ago, gas was seen as the ideal resource to support it, abundant, inexpensive , steady. But today, the crazy price of gas (or the crazy price of gas) is passed on (with a factor of 2) to the price of electricity since it is the last (gas-powered) power plant that we start up for balance supply and demand which sets the price (factor 2 coming from the efficiency of gas power plants: around 50%).

Thanks to the gains made by the price of electricity based on the marginal cost of the gas-fired power plant, producers based on other forms of primary energy for their power plant (wind, photovoltaic, nuclear, hydraulic) could recover a return on the invested capital. We talk about inframarginal rent and it was not a dirty word for a long time. This rent, with today’s gas prices, has become an unreasonable profit. Bills soar even if the electricity consumed does not come entirely from gas-fired power stations.

emergency solutions

Member States have all reacted with different emergency measures. The FSR counts seven of them! The simplest, reminds the author, is to isolate the retail price from the wholesale price. You can regulate the retail price. It can also be smoothed and applied with delay. This is what the French government did by asking suppliers to move the time when retail prices would reach their “logical” level. The Danish government is considering turning the price shock into a multi-year debt for the consumer. Another approach is to prohibit any increase in tariffs. And that’s what Britain did. We can also recover the inframarginal superprofits. They can be taxed afterwards at the level of the producers who benefit from these rents. France has been practicing this method for years even before the crisis by forcing EDF to sell a capacity of 120 TWh at a fixed price of 42-46 EUR/MWH. This is more than 40% of the country’s nuclear production, recalls the author! And to calculate that with a wholesale price of 200 EUR/MWh in the midst of the crisis, it is 24 billion in excess profits already recovered (but not redistributed, on the other hand) in France in 2022 alone. EDF only knows this Very good.

Spain invented its famous Iberian model by subsidizing the gas used for the marginal plant, which limits the marginal cost and therefore the wholesale price. The German model aims to offer individuals (and companies) enough additional income to meet the bills: it was the famous 200 billion euros distributed in this way that made the rest of Europe scream (for the advantage thus granted to companies) who cannot afford it.

Structural solutions are not for tomorrow

These emergency solutions cause States to lose precious financial means to invest in other forms of carbon-free energy, but there is no real alternative to relieve the consumer in the short term. A reform of the electricity market will not be effective before 2025, predicts the FSR and again, with the elections of the European Parliament and the new Commission that will have to be installed (painfully as always) in 2024, it is not won.

What strikes public opinion is the inability (or the laissez-faire attitude) of the States to let electricity prices go down, a basic need of the citizen while much is made of the price of bread. No longer having access to energy is a factor of total social exclusion. It is assumed that a citizen is in a situation of fuel poverty if he devotes 10% of his income to energy. However, even before the crisis, several Member States had entire sections of their population devoting 10% to 20% to it.

The State must also protect its suppliers against market volatility, either by obliging them to protect themselves with financial instruments or by granting them a guarantee. Need we recall the case of Uniper saved with tens of billions from bankruptcy in Germany, otherwise this country would have found itself without gas and electricity.

CfD and PPA

Contracts for Differences (CfDs) and Power Purchase Agreements (PPAs) are the tools FSR offers as necessary conditions for market reform. In the first case, the producer is guaranteed a price but if he sells his electricity above this price, he reimburses the difference. PPAs bind a professional client to a producer for a long period, but the State must guarantee that the latter can set up production capacities to honor its promise. And it would be better to have a less transparent PPA rather than OTC market which always results in sub-optimal conditions.

The flexibilization of demand is also part of the robot portrait of market reform, for the FSR, so as not to lose surplus production based on renewables to the point of selling them at a loss on windy or sunny days. As the proportion of renewables grows in the energy mix, this will happen more often. We must make smart meters and consumption inside homes as well.

Finally, a third lever is needed, a capacity market: remunerating producers for the capacity they install “just” when needed to avoid the fear that consumption peaks will not find an offer to satisfy them. But that’s not all: the FSR rightly explains that a capacity market can also remunerate innovative equipment and means of production whose return on investment cannot be recovered by simply selling electricity. We think of storage or flexibility services.

The distribution and transport networks are also not adapted to Europe’s ambitious renewable electricity plans: this preparation of the networks must be part of the reform of the markets, to avoid congestion, another source of volatility. prices. Europe wants millions of heat pumps in 2027: they will not work without a transformed network.

It is only at the price of more stable prices with a downward trend, without sudden peaks, that the citizen will want to electrify his house and drop his gas consumption little by little.

Alas, the European Central Bank (ECB) is maintaining high rates for the moment, which makes the investments to be made to accelerate investments at home, the deployment of more electricity based on renewable energy very expensive. And the state budget portends a debt crisis in full swing of transition. The portrait that the FSR gives of the electricity market today is in phase with the reality on the ground.


To know more : WORKING PAPER Reforming the EU internal electricity market in the middle of a huge energy crisis: an absolute short-term emergency or preparation for the future? Jean-Michel Glacahnt, Florence School of Regulation