Scared of scarcity: Electricity utilities question EU free market plans

At an event hosted by Eurelectric yesterday (7 June), a senior European Commission energy official told electricity firms that “if you can’t stand the heat, stay out of the kitchen”, when faced with concerns about proposals expressly designed to create frequent price spikes.

The Commission sees an increasingly volatile wholesale market as the solution to what is known in energy policy circles as the “missing money problem”. In other words, how to pay for wind farms, solar arrays and back-up generation when the leaves are still and the sun is obscured by cloud.

Oliver Koch, deputy head of the internal market unit in the EU’s energy directorate, was talking about “scarcity pricing” – where the cost electricity traded on exchanges is allowed to leap when demand outstrips supply – at an event hosted by the electricity utilities’ lobby Eurelectric.

Europe’s renewable energy sector is in a sense a victim of its own success: as its share of power generation has risen – to 28.8% in 2015 – it has pushed wholesale prices down, even below zero on occasion.

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The theory is that by removing price caps, subsidies and other market interventions, short bursts of potentially very high prices will enable investors to recoup the money they plough into new generation assets.

“The classic question, and maybe the most debated, is whether the energy only market is enough, or do we need a second market,” Koch said.

“Most of the experts agree today…that the more distortions you introduce into the market at first – through coal subsidies and even renewables subsidies and other interference with the markets – the more difficult it will be for the market price to give a signal that stimulates investment,” he added.

However, not all experts agree that a hands-off approach will be enough in the peculiar case of the electricity market.

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“Taking into account the political reality of the situation, no matter what they say in Germany, or Europe, it’s just not going to work,” said Graham Weale, an honorary professor of energy economics at Ruhr University Bochum.

“The point is, the very conditions that are necessary to generate scarcity prices of the magnitude needed for investment are precisely the conditions that don’t allow politicians to sleep well in their beds, and don’t allow them to be elected next time,” Weale argued.

“The police have raided the offices of one of the major Spanish utilities because of this kind of thing. Not the competition authority, not the energy regulator, but actually the police have raided their offices accusing them of manipulating the market,” said Juán Jose Alba Rios, the chair of Eurelectric’s markets committee.

This was an apparent reference to an investigation into Iberdrola, the latest development in a case dating back to 2013 that has already seen the Spanish multinational slapped with a €25 million fine by the country’s competition watchdog.

More recently, a January cold snap combined with low wind and solar output to push the price of electricity for next-day delivery to around €90/MWh, with consumers prices up by 26.2% compared to same month last year.

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The issue has even prompted questions in Brussels, with Spanish Greens asking the European Commission for its opinion. “At the end of the day, we are scared of having scarcity prices, because we know that whenever we have scarcity prices, even if we can get some extra revenue, it doesn’t compensate for the political, regulatory and legal risks that we have to take,” said Alba Rios, who is head of regulation at another Spanish utility, Endesa.

“I couldn’t agree more,” Koch said, before adding that meant progress cannot be halted just because people do not understand what is happening. “We go out with this package, and we tell people every day to embrace price peaks: they are not bad, they can be hedged,” he stated.

Every price spike in the UK causes a political stir, and the same thing can be seen in Spain, and people need to be convinced that they can benefit from unfettered price volatility. “This is a normal and efficient situation, provided we have effective monitoring… and an open market can hedge this so the overall effect is lower prices for consumers,” he said.

“Help us in that, we support you. But of course, with energy, if you can’t stand the heat, stay out of the kitchen. If you don’t want dawn raids, if you don’t have strict supervision, then don’t do energy business,” the Commission official said. “If you support us in our political discussion, then within five to ten years, no politician will have a nervous breakdown if prices peak, because they will peak every second day.”

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But the EU executive’s goal of an energy only market (EOM) is under attack not only from the scarcity sceptics. As Koch noted, there are some countries who have refused to get on board and continue to insist on the right to use their “not-so-clean” domestic energy reserves.

Poland, in particular, has argued consistently for the right to use state-backed capacity remuneration mechanisms (CRMs) to reward generators for keeping conventional coal-fired power plants up and running.

And hovering over the lawmakers who are currently trying to thrash out a compromise in the European Parliament and Council is the zeitgeisty threat of more disruptive change to Europe’s energy landscape. Although the Commission has tried to produce a market design that would be serviceable at least through the decade from 2020, Oliver Koch acknowledged the risk.

“Nobody predicted the Internet, nobody predicted all type of disruptive changes that made previous assumptions obsolete. Such changes may happen, are even likely to happen in the next five to ten years.”

If someone manages to crack the main problem with renewables – namely that their output is intermittent, while electricity is not easy to save for a rainy (or windless) day – the market design whose complexity is due in no small measure to the need for integrating green power into the system could quickly start to look dated.

“I don’t know whether Mr Musk will find the magic battery. If so, or if anybody else finds the magic battery the… network business may radically change,” Koch said.

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