This article is part of our special report Electricity prices.
Whether it’s for heating their swimming pools or to power their air conditioning systems and home appliances, regulated electricity prices “give the greatest potential benefit to richer households” who consume the largest amounts of energy, says Klaus-Dieter Borchard.
Klaus-Dieter Borchard is director for the internal energy market at the European Commission’s directorate-general for energy. He responded in writing to questions from EURACTIV’s energy and environment editor, Frédéric Simon.
The European Commission has proposed phasing out regulated energy prices as part of its clean energy package of legislation presented in November 2016. What were the main reasons behind this?
Regulated prices have been identified as a major barrier to the completion of the internal market for energy. The impact assessment, accompanying the Clean Energy Package, found that regulation of electricity prices limits consumer choice and restricts competition, as market entry of new suppliers is limited and consumers are disengaged from the switching process, in part due to the lack of choice.
There has been a consistent trend towards phasing out regulated prices in EU Member States since the introduction of the 3rd energy package. A significant gap has emerged in terms of market development between the 9 Member States that still have more than 80% of households under regulated electricity prices, and the remaining Member States, which are either in the process of phasing out regulated prices or that have done so historically.
Digitalisation, decentralisation and decarbonisation of the energy system are trends that offer significant new opportunities to consumers to take on new roles in the electricity system. In order to reap the benefits from this active consumers in all countries need access to market prices in order to respond with their own production, batteries or demand from electric vehicles in a way that helps balance the system when production is in surplus or deficit.
At the same time, we must recognise that not all consumers will be active or able to respond to price signals. The opportunity to choose fixed price contracts remains an option for those consumers that want stable prices. The most vulnerable consumers and those suffering from energy poverty must also receive targeted support via social policy and direct measures to reduce the cost of their energy bills, regardless of how our future energy system is designed.
The Commission has tried already lifting regulated energy prices in the previous energy package, which was concluded in 2009. However, it met with resistance from some EU member states, who voted it down. Did anything new happen since then that would justify a phase out?
The de-carbonisation and de-centralisation of the energy system comes with an increasing share of variable renewable electricity production, which has significant implications as mentioned previously. Moreover, falling technology costs make it easier for small consumers to produce and store electricity.
There is an increased need for active and flexible consumers to be able to react to the growing production from variable renewable energy sources and this requires market price signals to filter through to the final consumer. Only in this way can we ensure a cost-efficient energy transition where consumers are incentivised to participate.
For consumers to be rewarded in exchange for adjusting consumption or for putting electricity into the system, an accurate price signal reflecting the real value of electricity on the market is indispensable. This is not possible when supply prices are administratively set for all small consumers.
This is because this price signal must reflect the availability of electricity generation at an hourly basis or less, providing an incentive to, for example, charge an electric car when renewable generation is producing the most and perhaps discharging some volumes from the battery when prices increase due to lower production.
The deregulation of supply prices will also increase awareness among consumers that energy at times will be a scarce good and hence create incentives to use energy more efficiently or to consume less energy overall.
In addition, flexibility and energy efficiency on the consumer side also feeds back into wholesale markets and system costs as increased price elasticity of demand will help reduce price peaks (e.g. as demand is reduced when the price increases) or off-set price plunges (e.g. as demand picks up when wholesale prices drop towards negative prices).
Who are the main beneficiaries of regulated prices today?
In most Member States with regulated prices, household customers as well as other small consumers are eligible while in some Member States, price regulation is only applied to a targeted group of vulnerable consumers or energy poor in the form of social tariffs.
Such social tariffs appear to have a less negative impact on competition and consumer engagement when applied within the context of an otherwise liberalised market, as they are relatively limited in scope and usually apply to no more than 15% of consumers.
However, where general price regulation applies for all household customers, unlike in a targeted social tariff system, rich households receive the same price as poor households.
This results in a policy that not only fails to target vulnerable and energy poor consumers, but also ends up giving the greatest potential benefit to richer households, as these households are the ones consuming the largest amounts of energy under regulated prices.
Would you characterise regulated prices act as a kind of protectionist measure to shield former energy monopolies from competition?
Reasons invoked by Member States to justify price regulation vary. Some claim to use it as a tool to protect vulnerable or energy poor consumers, others claim that regulated prices are justified by a lack of competition.
In practice, regulated prices can be a significant obstacle for new actors to enter the market, in particular where they are fixed below the costs of new entrants, and hence perpetuate high market concentration as well as hinder innovation.
Maintaining regulated prices in markets with little competition will not allow the situation to improve but instead leads to long-term market stagnation and cost inefficiencies. In order to develop a competitive market we see the need for a phase-out period, during which a clear goal should be to reduce their scope and make retail markets more contestable.
Supporters of regulated prices argue they offer certainty to consumers, and shields the most modest households from energy poverty. What is your response?
Supply prices that reflect real electricity costs and that follow underlying wholesale prices (“dynamic electricity prices”) are actually shown to be the most beneficial to customers. This suggests that the closer the actual retail pricing comes to wholesale pricing, the greater is the benefit for consumers. The Commission’s key objective has been closing the gap between wholesale and retail electricity prices in all markets. In a renewables based system, this gap cannot be closed by regulation but only by market prices.
In the absence of price regulation, what are the most efficient ways of addressing energy poverty? What has the Commission proposed to address this problem?
Addressing energy poverty is an important component of the Commission’s political objective to deliver a balanced, consumer oriented and socially fair Energy Union.
The Clean Energy for All Europeans package encourages Member States to reduce energy poverty via targeted social and energy efficiency measures. Member States will be required to define, monitor and report on energy poverty levels while ensuring that energy efficiency measures benefit energy poor households and that long-term building renovation strategies contribute to reducing energy poverty.
Indeed, targeted energy efficiency measures can help address energy poverty in a sustainable manner. The new Energy Efficiency Directive requires Member states to implement a share of energy efficiency measures as a priority among vulnerable households including those affected by energy poverty and the new Energy Performance of Buildings Directive require Member states to include in their long-term renovation strategy an outline of relevant national actions that contribute to the alleviation of energy poverty.
To support Member States in identifying and addressing energy poverty the European Commission has set up a European Energy Poverty Observatory. Its key tasks are to collect and share accurate data and knowledge on energy poverty, reach out to stakeholders and provide technical assistance to interested parties.
Regulated prices haven’t stopped member states from installing impressive new amounts of renewable capacity over the last ten years. It also hasn’t stopped demand-response technology from making a promising start. So why the need to do this now?
The installation of renewable energy has been supported quite heavily through subsidies for many years. However, as technology costs decrease and technologies become more competitive, we will rely less on subsidies and more on market pricing in order to finance new renewable capacity.
Regulated prices can act as a barrier to the development of well-functioning markets needed to provide correct investment signals for future renewable capacity e.g. by lowering liquidity in more short-term wholesale markets needed to price renewable production.
Regulated prices can create a disconnection between the price signals of variable renewable generation and the prices that consumers have access to. If such a disconnection is present, then consumers would not be able to react in a timely manner to changes in renewable energy production – which is the objective of demand response.
Currently, only 2-3% of peak demand is activated as demand side management in Europe. By 2030 and with the right policy framework in place, which includes phasing out regulated prices, this should grow towards 10% of peak demand or 50 GW – leading to benefits of €5.6 billion per year.
Tapping into this potential for demand response will be required to integrate the growing share of renewable energy into the electricity system in a cost-efficient manner and may ultimately be required to do so safely up to the level required by our ambitious 2030 renewable energy target of 32% which translated into a share of about 55% for the electricity sector.