Market-based Options for Security of Energy Supply

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This paper summarises the main findings of the INDES project, which has set out to reducing complexity and making security of supply operational by taking an approach that is both compatible with the market and cost-effective.

Abstract

Working Paper No. 1 on Market-based Options for Security of Energy Supply presents the synthesis of the INDES project and brings together the main findings after one year of work. This is a policy-oriented contribution and seeks to present the project’s main findings and recommendations concisely. Hence, to fully appreciate the INDES project work, this Working Paper should be read in conjunction with the other six Working Papers in the INDES series, to which references and hyperlinks are provided in this report.

I. Security of supply in open markets

Energy market liberalisation and growing international economic interdependence have affected governments’ ability to react to security-of-supply challenges. The EU internal market has changed the policy instruments available to governments as well as altered the reference framework for policy and market participants alike. Whereas in the past security of supply was largely seen – with some exceptions – as a national responsibility, the frame of reference has increasingly become the EU and the European Economic Area (EEA). What constitutes the ‘European dimension’ of security of supply and what are the ‘new’ ingredients of such a policy are important questions.

In general, liberalisation increases security of supply by increasing the number of market participants and improving the flexibility of energy systems. Liberalisation may also pose new risks, such as those associated with reserve capacity or consistency with environmental or economic objectives. Moreover, governments may need to re-assess the level of security of supply they seek to achieve. Markets make the costs of security of supply more transparent, which in turn can lead to a situation where consumers are prepared to pay a premium for increased security of supply or to accept a reduced level of security in exchange for lower prices. The main effect of liberalisation, however, is that it has shifted the prime responsibility for achieving security of supply from governments towards the inclusion of market participants. Fully competitive markets significantly reduce the scope for intervention by governments. Over the long term, measures that rub against the grain of the market are not only unrealistic and ineffective, but may also impede European competitiveness. Markets can actually serve as very effective and efficient tools in achieving policy goals: governments establish the objectives and set the rules that enable firms to achieve those objectives. As a result, security of supply has become a common responsibility shared among firms, governments, and whenever applicable, individual consumers.

II. Scope of project and research approach

In this logic, security of supply becomes a risk-management strategy with a strong inclination towards cost-effectiveness, involving both the supply and the demand side. Security of supply has two major components that interrelate: risk and cost. This project has mainly concerned costs and attempted to develop a ‘market-compatible approach’, geared towards securing supply. To follow a market-compatible approach is to identify risks and costs, deal with them by focusing on cost-effectiveness and utilise a broad ‘arsenal’ of policy instruments. The latter forms the ‘insurance’ component of this project.

In considering costs, it is crucial to analyse the costs of energy disruptions, which fall under two categories: private and social costs. There is a growing – although still small – body of literature on private costs, both theoretical/methodological and empirical. This literature, still inconclusive, is reviewed at the end in section 5.

This Working Paper is organised as follows:

1. The approach is presented in section 1, in the Introduction;
2. Section 2 provides guidance as to how to make security of supply operational by introducing an exemplary eight- step decision tree;
3. An extensive section 3 presents the main conclusions and recommendations on natural gas import-dependency [3.1], natural gas infrastructure and investments [3.2], oil with special reference to transport [3.3] and electricity adequacy [3.4];
4. Section 4 provides a synthesis of geopolitics for oil and natural gas, which serves as background for the preceding analysis in section 3; and
5. Section 5 adds a review of the literature on private and social costs.

The INDES project has set out to ‘reduce’ complexity and aims at making security of supply operational. By following a rigorous, market-compatible approach it has attempted to introduce a variety of instruments wherever these could provide optimal solutions in the short and long term. Again, the guiding principles are market compatibility and cost-effectiveness.

III. Conclusions and recommendations

This section summarises the essential conclusions and recommendations of the INDES Working Papers. More detailed analysis and conclusions are presented in later sections of this paper, to which we refer in brackets. These are organised in line with the research objectives laid out in section 1: a descriptive map of security risks, security responses in the supply chain and a review of research on private and social costs.

Giacomo Luciani is with the Mediterranean Programme at the Robert Schuman Centre, European University Institute.

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