EC Proposed Reform of the EU Electricity Market

On March 14, 2023, the European Commission (the “Commission”) presented its working document including two proposals for (i) improving the EU electricity market design and (ii) protecting the wholesale energy market from market manipulation.[1]

The proposed reform follows a consultation the Commission started on January 23, 2023 and ended in February 13, 2023, where market respondents expressed support for longer term price signals and market-based mechanisms.[2]  On the one hand, the Commission proposal to improve the EU electricity market design aims at amending Regulation (EU) 2019/943 (“Electricity Regulation”),[3] Regulation (EU) 2019/942 (“ACER Regulation”),[4] Directive (EU) 2019/944 (“Electricity Directive”)[5] and Directive (EU) 2018/2001 (“Renewable Energy Directive”)[6] to pursue a triple objective of (i) boosting renewable energy investments; (ii) better protecting and empowering EU consumers; and (iii) enhancing the competitiveness of EU industry.  On the other hand, the Commission proposal to improve EU protection against market manipulation in the wholesale energy market, aims at amending ACER Regulation and Regulation 1227/2011 on wholesale market integrity and transparency (“REMIT”).[7]  The main shortcoming the proposed reform aims to address is the strong volatility of wholesale electricity prices, influenced by the sharp increase in natural gas prices observed in 2022 following the war in Ukraine.  The Commission’s staff working document of the reform, encompassing the two above mentioned proposals, is structured around the seven following topics.

1. Making Electricity Bills More Independent from the Short-Term Cost of Fossil Fuels. 

As anticipated by the consultation, the Commission wants to support the development of contracts over the long term: either (a) private contracts between power producers and consumers for 5 to 10 years, and up to 20 years, i.e. Power Purchase Agreements (“PPA”), or (b) contracts between a generator and a public entity on behalf of consumer for more than 10 years, i.e. two-way Contracts for Difference (“CfD”)[8], in order to ensure that energy bills become less dependent from the fluctuation of prices in short-term markets.  The proposed reform also aims to support (c) forward contracts, (d) energy sharing between active customers, and (e) guarantee offshore transmission.

• National measures to support PPA market.  Even if the EU has experienced a growth of PPAs volume until 2021, the market remains accessible only for large credit-worthy companies due to price risks.[9]  PPAs do not exist in many different sizes and duration, so that adaptation to specific consumer needs, in the absence of standardisation, adds high transaction costs and complexity.  The development of this market is also hampered by the difficulty to establish credit worthiness of potential buyers and regulatory barriers at national level.[10]  To address these obstacles, the Commission’s proposed reform calls for national measures, and especially national financial instruments, to cover against default risks, including guarantee schemes that can be designed in a way that do not constitute State aid.  To finance new renewable electricity projects and reduce risk exposure, the Commission recalls the complementarity of State aid for renewable generation and PPAs, rather than two alternative channels: the Commission encourages Member States to ensure that bidders to public tenders are allowed to reserve part of the project’s generation for a market-based revenue stream and that they use evaluation criteria in the public tender that incentivizes access to the PPA market.[11]
• CfD for decarbonized investments.  For new investments in low-carbon, non-fossil fuel generation technologies,[12] the Commission describes in its proposals the principles for designing national public support schemes, to complement the Renewable Energy Directive.[13]  The proposed reform promotes especially the recourse to two-way CfD to allow the generator for a revenue guarantee for the electricity produced but with an upward limitation when market prices are high.  The pay-out generated by CfD when market price exceeds the strike price, will have to be used by Member States to directly reduce electricity bills of customers.  In its proposal, the Commission encourages several contractual features of CfD such as a uniform and equal clawback to consumers based on their consumption and penalty clauses in case of early termination by the producer.  The Commission excludes early stage market deployment technologies from the application of the described principles.[14]
• Hubs-based hedging for forward markets.  A forward contract, by which a customer and a generator agree to buy/sell a certain amount of electricity at a certain price in the future, helps to hedge price and decrease dependence on short-term prices.[15] The proposed reform seeks to further integrate forward markets by creating reference regions called “virtual hubs-based hedging”, complemented with accessible longer-term zone-to-hub transmission rights.  These regions will reflect the aggregated price of several bidding zones, increasing liquidity and thereby hedging possibility.  These hubs are characterised by a reference price, which should be used by market operators to offer forward hedging products.  System operators need to provide transmission rights, both on a regular basis and with a longer maturity (up to 3 years ahead).[16]
• Enabling energy sharing.  The Commission proposes to add an enabling framework for energy sharing in the Electricity Market Directive.  The prosumers should have their injected electricity deducted from their total metered consumption, within the same bidding zone for the calculation of the energy bill.  The Commission leaves to Member States’ discretion the calculation and allocation methods for sharing of renewable energy, the protection of vulnerable households to access energy, and the design of model contracts with fair terms.[17]
• Offshore Transmission Access Guarantee.  In order to tackle the risk of transmission system operators (“TSO”) reducing transmission capacity made available to offshore wind farms, the Commission proposes to develop a “Transmission Access Guarantee” (“TAG”) where TSO compensate offshore producers when not allowing the export of energy, through a congestion income re-allocation.[18] 

2. Limiting Revenues of Inframarginal Generators.

As explained in the proposal, the original idea behind inframarginal cap was to limit the impact of the natural gas prices on the revenues of all inframarginal generators and to generate revenues allowing Member States to mitigate the impact of high electricity prices on consumers.  However, the Commission acknowledges that these caps come with risks if installed as permanent features of the market design and announces it will further monitor their effect to then decide on their possible prolongation beyond 30 June 2023.[19]

3. Improving the Efficiency of Short-term Markets.  

The Commission considers that system operators should increase transparency surrounding the availability of grid connection capacity and trading deadlines should be brought closer to real time for a more efficient trade of renewables and balancing.  The Commission proposes to set the cross-border intraday gate closure time closer to real time, in order to allow market participants to trade as close as possible to the time of delivery of the electricity and, then allow them to balance their position, which is particularly important for wind and solar producers.[20]  

4. Facilitate and Incentivise Non-Fossil Flexibility Services for Renewables Integration

Flexibility solutions should be preferred over grid development.  However, based on the majority of national regulatory frameworks which are biased in favour of CAPEX over OPEX, system operators are discouraged from choosing a flexibility solution resulting in OPEX rather than an investment in infrastructure resulting in CAPEX.[21]  Therefore, the Commission recommends to correct these frameworks to revalue the importance of OPEX, in order to encourage further flexibility services.  The Commission is also promoting a shift towards an efficient mix of CAPEX and OPEX in tariff structures to speed up investments in smart and digital electricity grids.[22]

In addition, the Commission is announcing the launch of a study in 2023 together with ACER for new rules on aggregation, energy storage and demand curtailment, to further support the development of demand response.  System operators are also encouraged to use sub-meter data for settlement and observability process of demand response.  The proposal announces that these two last elements will be detailed in the future Network Code.

Concerning incentives for non-fossil flexibility, the Commission’s proposal develops five points,[23] i.e.:

• Periodical assessments by national regulators of the need of flexibility in the system, and subsequent centralisation by ACER to give cross-border recommendations.
• Low-carbon capacity mechanisms (i.e., setting a low CO2 cap and adding flexibility requirements) when supporting the development of clean flexibility solution by capacity payments, implying a joint reading of the Electricity Regulation and State aid guidelines.   
• Capacity payments, as the form of non-fossil flexibility support schemes.  These schemes are designed as a competitive bidding process and aim at providing more stable revenues.
• “Peak shaving” products, for system operators to incentivise consumption reduction in peak time and with consumers being paid for demand reduction at certain hours of the day.  

5. Better Consumers’ Protection and Empowerment.

The proposed reform empowers consumers with new rights, wider contractual choice with clearer pre-contractual information.  Apart from energy sharing and protection of vulnerable consumers from disconnection already discussed above, the Commission elaborates on the following elements:

• Fixed price contracts.  The reform will impose suppliers with more than 200 000 customers to offer fixed-price contracts for at least one year.  In each Member State, the consumer should have access to at least one fixed price contract.  While the prices of these contracts are freely determined by the suppliers, they cannot unilaterally modify the terms and conditions before the contract’s expiration.[24]  
• More than one meter.  The consumer shall have the right for more than one meter installed in their premises and sub-metered consumption to be deducted from the main metering and billing.  The proposal calls for a clarification of the Electricity Directive to allow consumers to have multiple or combined tailor-made contracts, with more than one supplier.[25]
• Hedging strategies.  To mitigate volatility risks at the expense of consumers, the Commission proposal wants suppliers to put in place appropriate hedging (i.e., buying the necessary electricity on forward markets) strategies, under the assessment of Member States.
• Suppliers of last resort.  Member States must establish suppliers of last resort, to which consumers are switched to in case their suppliers fails.  The proposal reform does not give much more information at this stage.[26]
• Price setting intervention.  The reform provides that, in case of emergency, high energy prices could be regulated below cost without the need to adopt a new legislation.  Member States can apply for price intervention for households and SMEs, for a limited volume of electricity consumption and limited period of time.[27]  This derogation should be activated only when three cumulative criteria are met: (i) wholesale electricity markets prices increase, reaching 2,5 times the average price during the previous 5 years, expected to continue at least 6 months; (ii) retail electricity prices increase of at least 70%, expected to continue at least 6 months; and (iii) the wider economy being negatively affected by these increases. Regulated prices are restricted to 80% of the median consumption for households and 70% of historical consumption for SMEs.

6. Enhance the transparency of the energy market and protection against market manipulation.  

The proposal highlights the weaknesses to be tackled concerning REMIT, the Regulation  against insider trading and market manipulation in wholesale energy markets, including gaps in data and lack of enforcement of reporting obligation at the EU level.  For example, REMIT’s definition of market abuse does not include capacity withholding.  The Commission then recommends different elements, namely: (i) REMIT’s adaptation; (ii) improved collection process of inside information; (iii) enhanced supervision of reporting parties (mainly to equip ACER with additional supervisory tools) and of “persons professionally arranging transactions”; (iv) enhanced market transparency through LNG price assessment and benchmark; and (v) the strengthening of investigations (mainly for cross-border cases).  With this amendment to REMIT, the Commission wants to enable both national and EU authorities to effectively monitor the competitiveness and transparency of the energy market.[28]

7. Generation and system adequacy for a decarbonized electricity system.

• Generation adequacy and capacity mechanisms. To ensure generation adequacy and security of electricity supply, several EU Member States have introduced capacity mechanisms, allowing power generators and other technologies to request subsidies under certain conditions, such as demand response and storage.  The Commission recalls that the Electricity Regulation allows Member States to set technical performance standards and CO2 emissions’ limits that restrict participation in these mechanisms to flexible, fossil-free technologies[29] and that the recently revised State aid rules even encourage Member States to introduce green criteria in capacity mechanisms with stricter rules for the approval of subsidies to coal and gas-fired power plants.[30]  The Commission proposes to clarify the legislative framework by introducing in the amending Electricity Regulation a Recital explaining how the Electricity Regulation and State-Aid Guidelines can be read together to design a green and flexible capacity mechanism.[31]
• Locational signals.  In its proposal, the Commission acknowledges the benefits of a more granular market design.  Taking into account the actual geographical location of the supply and demand permits to directly include congestion in the grid and network constraints in the wholesale market price.  Locational pricing allows for lower electricity prices at locations with large energy production from renewables, incentivising appropriate investment decisions, including to meet hydrogen objectives.[32]  However, the current proposal only includes some locational elements, without revolution towards a proper locational pricing.

Next steps

Announced by President von der Leyen in its the State of the Union speech in September 2022, the reform of the EU electricity market design has been included in the Commission’s 2023 Work Programme.  The proposed reform will now be discussed, and perhaps amended, by the EU Parliament and the Council following the ordinary legislative procedure.  It will enter into force when an agreement will be reached.

Conclusion

If the reform of the EU electricity market is adopted as proposed, there will be an uptake of stability support strategies, such as facilitated access to PPA, CfD and forward markets.  Member States will be required to provide instruments such as guarantee schemes to help companies enter PPA market and choose CfD for investment support in low carbon generation.  Electricity retail companies will have to hedge appropriately relying on long-term markets.  In the forward markets, newly created reference regions will improve liquidity and improving hedging to oblige system operators to provide transmission rights.  Consumers will benefit from more protection, empowered with new rights and wider contractual choice, such as long-term fixed-price contracts, decoupling their electricity bills from price of gas.

[1]  Commission staff working document concerning the Reform of Electricity Market Design, of March 14, 2023, available here, accompanying the Proposal for a Regulation of the European Parliament and the Council of March 14, 2023, amending Regulations (EU) 2019/943 and (EU) 2019/942 as well as Directives (EU) 2018/2001 and (EU) 2019/944 to improve the Union’s electricity market design (COM (2023)148 final), and the Proposal for a Regulation of the European Parliament and the Council of March 14, 2023, amending Regulations (EU) No 1227/2011 and (EU) 2019/942 to improve the Union’s protection against market manipulation in the wholesale energy market (COM(2023) 147 final).

[2]  See for more background Cleary Gottlieb’s previous post, available here. The Commission received 1369 contributions to the public consultation, including among others a large number of citizens, companies, business associations and NGOs. The Commission also held a stakeholder workshop on 15 February 2023 to gather views on the public consultation.

[3]  Regulation (EU) 2019/943 of the European Parliament and of the Council of June 5, 2019 on the internal market for electricity (recast), (OJ L 158, 14.6.2019, p. 54-124).

[4]  Regulation (EU) 2019/942 of the European Parliament and of the Council of June 5, 2019 establishing a European Union Agency for the Cooperation of Energy Regulators, (OJ L 158, 14.6.2019, p. 22-53).

[5]  Directive (EU) 2019/944 of the European Parliament and of the Council of June 5, 2019 on common rules for the internal market for electricity and amending Directive 2012/27/EU, (OJ L 158, 14.6.2019, p. 125-199).

[6]  Directive (EU) 2018/2001 of the European Parliament and of the Council of 11 December 2018 on the promotion of the use of energy from renewable sources, (OJ L 328, 21.12.2018, p. 82-209).

[7]  Regulation (EU) 1227/2011 of the European Parliament and of the Council of October 25, 2011 on wholesale energy market integrity and transparency, (OJ L 326, 8.12.2011, p. 1-16).

[8]  Usually by a competitive tender and setting a strike price.  If the market price is below the strike price, the generator receives the difference while if it is the contrary, the generator pays back the difference.

[9]  See Figure 3 “Evolution of the PPA market in Europe”, in Commission staff working document concerning the Reform of Electricity Market Design, p. 20.

[10]  Ibid., p. 21.

[11]  Ibid., p. 23.

[12]  Ibid., p. 32, this include investments in new power generating facilities or investments aimed at repowering existing power-generating  facilities, including to prolong their lifetime for example.

[13]  Directive (EU) 2018/2001, op. cit., articles 4 to 6 contain the relevant principles applicable to the design of support schemes for renewables, applicable without prejudice to Articles 107 and 108 TFEU and the related legislation and guidelines, especially the Communication from the Commission – Guidelines on State aid for climate, environmental protection and energy 2022, C/2022/481, (OJ C 80, 18.2.2022, p.1-89), available here.

[14]  Commission staff working document concerning the Reform of Electricity Market Design, p. 33.

[15]  Similar to a PPA but for a shorter time period, see Commission Q&A, available here.

[16]  Commission staff working document concerning the Reform of Electricity Market Design, p. 39.

[17]  Ibid., p. 43.

[18]  Ibid., p. 48.

[19]  Ibid., p.50-51 referring to inframarginal revenue cap put in place by Council Regulation 2022/1854 of October 6, 2022 on an emergency intervention to address high energy prices, (OJ L 261I , 7.10.2022, p. 1-21).  

[20]  Ibid., p. 54.

[21]  Ibid., p. 63.

[22]  Ibid., p. 64.

[23]  Ibid., p. 73-74.

[24]  Ibid., p. 78.

[25]  Ibid., p. 85.

[26]  Ibid., p. 86-87.

[27]  Ibid., p. 89.

[28]  Ibid., p. 96-102.

[29]  See emissions limit in Article 22 of the Regulation (EU) 2019/943, op. cit..

[30]  See Guidelines on State aid for climate, environmental protection and energy 2022, op. cit..

[31]  Commission staff working document concerning the Reform of Electricity Market Design. p. 105.

[32]  Ibid., p.108.