Planned EU electricity market reform

On March 7, 2023 the draft of the European Commission’s Market Design proposal started being circulated. It highlights amendments to the electricity market and renewable energy sources (RES) framework that are aimed at improving resilience to energy price shocks and competitiveness of businesses and industry, and securing social welfare through affordable electricity. Moreover, the proposal promises to drive investments in RES, storage and demand-side response (DSR) solutions through greater focus on forward, long-term hedging instruments and creating demand for flexibility services. Read on for a summary of the proposal and our initial reaction.

Changes to electricity market regulation, directive and to RED 2

The Commission’s proposal includes amendments to Regulation (EU) 2019/943, Directive (EU) 2019/944, Directive (EU) 2018/2001 (RED 2) and Regulation (EU) 2019/942 (ACER regulation) to “improve the EU’s electricity market design”. Officially, the Commission will present their legislative proposal (Proposal) on March 16, 2023. The Proposal will then enter into official legislation proceedings and be subject to possible changes during the trilogue proceedings with the Council of Europe and the Parliament. However, the current draft provides important insights into the key objectives the Commission wishes to pursue and the tools that will extend the electricity market framework.

The Proposal is a systematic answer to the energy price spikes and volatility in electricity markets experienced since 2021, mainly due to the high wholesale price of and demand for natural gas. The cost of fossil fuels translates into high market clearing prices whenever demand increases or when renewable technology output proves insufficient to cover demand. In 2022 the energy crisis affected even forward markets, accounting for fossil fuel scarcity concerns.

Now, the Commission is building on the temporary measures adopted in 2022 to urgently address the energy price crisis and security concerns, with the goal of creating a buffer between short-term markets and electricity bills of consumers and increasing flexibility of the grids, both to integrate more RES and to better manage the demand side.

Crisis management measures

The Proposal includes very limited crisis management tools. They focus on consumer protection, allowing member states to extend access to affordable (i.e., regulated) electricity prices to SMEs or to temporarily set supply prices for micro-enterprises and households at below cost, with compensation for suppliers.

The Commission would coordinate this crisis response — monitoring the market against sustained high prices and declaring a regional or EU-wide state of market emergency, for a period of up to one year — whenever a triggering of those tools becomes necessary. Member states will need to observe several strict cumulative criteria when applying public interventions to electricity prices.

The Proposal does not support claw-back measures targeting windfall profits as a standard market design feature, concentrating instead on long-term measures to reduce price volatility, better integrate renewable supply and encourage demand response to mitigate standard market-price pressures.

The Proposal does not clarify whether the temporary revenue caps for generators and traders (in some countries), currently applying until June 30, 2023, might be extended. Hence, policy signals arriving from Brussels should be monitored closely.

No fundamental changes to electricity market design. Strengthening short-term and forward markets

Generally, the Commission proposes that a faster deployment of renewable energy and clean flexible technologies constitutes the most sustainable and cost-effective way of structurally reducing the demand for fossil fuels for electricity generation and dependence on the volatile variable cost of electricity generation. This, paired with electrification of heating and transport, should shield markets and consumers against power price increases.

Short-term power markets remain a key tool for the integration of renewable energy — the Commission is pursuing greater flexibility of intra-day markets and standardized peak-shaving system services, ensuring surplus renewable generation is efficiently utilized and market access barriers are reduced. Intra-day gate closure times would be reduced and a lowering of the minimum bid size from 500 to 100 kW will ensure that small-scale flexibility can participate.

Forward markets should be incentivized to allow suppliers and consumers to hedge against the risk of future volatility in electricity prices. The Commission proposes to achieve that in a number of ways: fine tuning subsidy schemes (the preferred option being two-way CfDs), developing corporate PPA markets by promoting guarantee schemes and increasing their availability to a larger pool of consumers, and facilitating access to forward transmission capacities for cross-zonal electricity delivery and price hedging.

More measures to promote demand response and storage

Network tariffs should incentivize system operators to use flexibility services by further developing innovative solutions to optimize the existing grid and in procuring flexibility services, in particular based on demand-response and storage. Member states should set national objectives for demand-side response and storage, which should also be reflected in their integrated National Energy and Climate Plans. Through this link the Commission would allow such projects to better access funds within the Resilience and Recovery Facility, still utilized to a limited degree by many member states.

Member states that apply a capacity mechanism would be required to promote the participation of demand-side response and storage by introducing additional criteria or features in the design. The Proposal lays out design principles for flexibility support schemes dedicated to DSR and storage.

Furthermore, transmission system operators would be prompted to design standardized, short-term peak-shaving products that remunerate market participants for reducing electricity consumption or use stored energy at peak hours. Interestingly, remunerated peak shaving products would not include ramping up behind-the-meter generation to reduce demand for network supplier electricity.

No material changes to current RES auction support system

Generally, the current RES auction support system guidelines are not expected to see substantial changes. As part of the support schemes for new generation, the Commission is promoting the implementation of a two-sided contract for difference (CfD) with the respective state counterparty and preventing early termination of participation in the support scheme. This limits the design choices — requiring generators to transfer revenue above the agreed strike price towards the state counterparty — as opposed to one-sided CfDs and sliding premium schemes implemented in some member states.

Reserving some electricity for sale through private PPAs would be promoted by beneficiary selection criteria, which the Commission believes would further contribute to the development of power purchase agreement markets.

The Proposal does not include amendments to the financial stability clause, protecting existing RES support schemes against changes that would impair the financial viability of projects already enjoying public support. We therefore believe there would be no room to impose two-sided contracts for difference on existing projects.

As a novelty, location criteria would have to be considered in future for assessing auction bids. This would ensure that new investments in generation take place in optimal locations and not create or worsen congestion in the grid. The Proposal does propose to reinforce the transparency of available grid connection capacity, clarifying how network operators should share that information with the market. However, with structural congestion already giving grounds for concern in numerous jurisdictions, we believe such location criteria could become a useful tool, but only when strongly linked to other measures ensuring greater network flexibility and actual availability of connection capacity matching the expected rollout of new RES generation investment.

Strengthening of (corporate) PPAs

It is intended to strengthen long-term (corporate) power purchase agreements as an efficient hedge against short-term price increases. We endorse the Commission’s clear message that market participants should retain the freedom of contracting choice.

Explicitly, the option to combine CfDs and PPAs is intended and should be rewarded in CfD subsidy tenders, e.g., giving preference to bidders presenting a commitment from a potential buyer to sign a PPA for part of the project’s generation. Generally, member states should ensure that instruments in the framework of PPAs to reduce the financial risks associated with offtaker payment default are accessible to companies that face entry barriers to the PPA market and are not in financial difficulty. Appropriate state aid measures, like guarantee schemes, are explicitly permitted by the Proposal.

Further empowering active consumers by energy sharing

The Commission emphasizes that energy sharing by RES generators with up to 100 MW total installed capacity will be especially promoted. Active customers that own, lease or rent a storage or generation facility will have the right to share excess production and empower other consumers to become active, or to share the renewable energy generated or stored by jointly leased, rented or owned facilities, either directly or through a third-party facilitator. Member states will have to put in place an appropriate IT infrastructure to allow for administrative matching within a certain timeframe of consumption with renewable energy self-generated or stored by active customers. Additionally, Member states will have to ensure that all customers are free to have more than one electricity supply contract at the same time, provided that the required connection and metering points have been established. To this end, customers will be entitled to have more than one metering and billing point covered by the single connection point for their premises. Active customers will be entitled to have the shared electricity netted with their total metered consumption within a time interval no longer than the imbalance settlement period and without prejudice to applicable taxes and network charge.

Implications for the Polish power market

Market participants in Poland will appreciate a number of clarifying rules that strengthen their position already when dealing with a number of prevailing market hurdles. The Proposal reinforces Dentons’ earlier assessment of admissibility of behind-the-meter rent or lease agreements for RES generation and illustrates how the current practice of network operators withholding information about the location of available capacity and actual state of the network (common in ongoing connection disputes handled by the Polish Energy Regulatory Authority) cannot be justified and sustained.

Due to increasing concerns about dispatchable capacity, we expect the Polish capacity mechanism will soon be modified to promote the participation of storage — through the introduction of additional features included in the Proposal to the current design. Other needed measures will take longer to implement. Notably, several elements of the Proposal will not be adopted until it eventually becomes binding law.