The liberalisation of power markets has led to substantial changes in the way electricity is generated and used. It created competition in a traditionally monopolistic and conservative industry, allowing new business models to emerge and new players to challenge incumbent utilities. Konrad Purchała explains.
Konrad Purchała, Ph.D., is the director for European Integration Policy at PSE.
The simultaneous shift in policy toward more sustainable and environmentally friendly energy supplies, along with significant incentives for renewable power investors, has led to tremendous innovation in these generation technologies. Now market conditions are completely different from what they were before liberalization started some 20 years ago. Competition brought greater efficiency, as well as new challenges for market players.
Europe’s electricity market is a unique undertaking: It’s unprecedented to see 28 countries overhaul the way a vital service such as energy supply is designed.
The EU is progressively harmonizing its national and regional electricity markets, to form a single market that benefits more than 500 million people.
The absence of restrictions on electricity trade between European countries, except for the availability of cross-border capacity, is a big achievement. The Multi-Regional Coupling organized by European power exchanges is clearing day-ahead markets and determining day-ahead prices in a coordinated manner across the countries involved. This, in turn, is helping form prices more efficiently and, as a result, use energy more efficiently too.
The European electricity industry can be proud of the last two decades. However, Europe’s market design is by no means flawless.
The market is divided into bidding zones, and is based on the assumption that trading opportunities within those zones are unlimited. Trade between bidding zones, however, is limited to the level of cross-border capacity. That creates boundaries on how much trade is technically feasible.
This treatment of cross-zonal trade versus trade within bidding zones is now of particular interest to European regulators and policymakers. Although this difference in treatment is inherent to the zonal market design, the fact that it implicitly prioritizes internal trade over cross-border trade may raise concerns over the foreclosure of national markets, and create barriers to competition. Heated discussions on how cross-border capacity is calculated, setting the limit on trade between zones, could change the way Europe’s entire zonal market is organized.
The inability to make more capacity available is one of the biggest obstacles to market efficiency. Although clear coordination rules are embedded in the EU’s legally binding market regulations, known as network codes, they have yet to be implemented. As a result, cross-border trade is undermined by some of the side effects of the zonal system, such as loop flows stemming from internal transactions causing flows across neighbouring grid or unscheduled transits resulting from insufficient coordination or cross-border trade. This causes physical power flows to fall significantly off market schedules.
Transmission system operators need to anticipate such uncoordinated flows and take measures to keep the power system secure, by limiting the potential for cross-border trade. Operators also have to reschedule the output from power generation plants when the market demand cannot be supplied due to grid limitations. Uncertainty about cross-border capacity calculations makes the process more of a crystal ball-reading than technically sound engineering.
The amount of generation output that is rescheduled, or re-dispatched, has grown significantly in recent years. What is even more worrying is that the wholesale energy market, and the strictly technical re-dispatching zonal market, are sequential but based on completely different rules. This makes the market vulnerable to gaming, especially as transmission system operators work to meet the expectations of stakeholders and energy regulators to make grid operations more transparent.
Unfortunately, these European market design flaws are very difficult to overcome without fundamental changes.
The zonal design was relatively simple to implement, with quick benefits for market integration. But it is increasingly evident that the zonal market is a dead-end path. So while market design simplifications may have been good for initial integration, they are becoming an obstacle to efficiency in the use of generation and transmission resources.
The quality of bidding zones exemplifies of this problem. It is a decisive factor in the success of zonal markets and flow-based allocation. Yet unfortunately, European bidding zones are not designed to match those technical requirements. Instead, with the exception of a few countries like Norway, Sweden, Denmark and Italy, European zones are based on political borders.
The definition of a bidding zone can be a highly political issue. Many countries are not ready to consider splitting their national bidding zones, even though EU legislation makes it fundamental to cross-border market efficiency.
The existing zonal market and cross-border trade, based on forecasts of cross-border capacity rather than actual capacity, will therefore lead nowhere.
Substantial improvements in price signals, which can facilitate efficiency in the use of generation and load resources, are simply impossible under large zones. Market and system operations will remain detached — even more so with the increased intermittency from renewable power and demand-response systems. Regulatory attempts to artificially increase cross-zonal capacities, by ignoring physical power flows, will only detach them further.
The future power system will require new market solutions!
The power system is changing. The renewable energy revolution, along with customer empowerment and growing demand flexibility, are shaking the electricity industry. Innovative technologies are becoming technically and economically viable, translating into business opportunities.
It is vital that these new businesses develop under the right regulatory framework, so that they serve the needs of all end-users to the benefit of society at large, without prioritizing certain stakeholders at the expense of others.
Price signals will become even more fundamental to system operations. There will be no other way to manage distributed energy resources except to differentiate prices by location, reflecting the needs of the power system and all consumers.
Given that it cannot implement smaller zones, Europe should consider fundamentally changing the market towards Locational Marginal Pricing, also called nodal pricing. This system is long-established by academics as the reference for efficient electricity market organization.
Instead of ideologically defending the EU market model against the US model, the EU would be much better off focusing its talent and brainpower on implementing this 21st-century electricity market.