Expert Paper – Electricity Market Design

Whilst this year marks the 30th anniversary of the Single Market, the EU is facing several challenges related to geopolitical tensions, supply chain disruptions and an energy crisis of unprecedented proportions that weaken the competitiveness of the block’s industrial base.

A competitive, liquid and integrated wholesale electricity market underpins the European Single Market. In times of stress, the current framework proved its worth by revealing the short-term price for electricity, appropriately valuing energy savings, and allowing energy to flow freely and timely across borders to where most needed, thus ensuring security of supply despite two supply shocks in gas and power. The fast-tracked reform proposal expected in March should build on the strengths of the energy market (IEM), avoiding measures that weaken it, such as the prolongation or even institutionalisation of the current revenue cap on inframarginal generators, applied at different levels across the EU.

The high electricity prices, particularly in spot markets, are a fundamental expression of a supply deficit in gas and power and have an impact on the forward contracts. While the signal only shows an outcome of the market equilibrium condition, the resulting prices are not desirable and not sustainable for long periods of time.

The regulatory uncertainty created by different interventions, together with the current spot price levels and correspondingly high margin calls, also drained liquidity in the Power Purchase Agreements (PPAs) and forward markets.

Building on the strengths of the current market design, the European Commission’s proposal should enhance the current framework by enabling more long-term instruments appropriate for the different hedging needs of different off-takers. Long-term contracting helps contain the influence that short-term prices have on prices accessed by consumers. Thus, an effective ‘decoupling’ effect between short-term and final customer prices can be achieved, without affecting the marginal pricing system that guarantees the most efficient short-term use of resources.

Ultimately, the goal of the reform of the IEM is to deliver the necessary volumes of investments in new flexible and firm capacity that will allow the EU to overcome the supply crisis, provide access to affordable carbon-free electricity to consumers and achieve the Green Deal climate goals.

Any reform going beyond targeted adjustments to the existing framework should be underpinned by an in-depth impact assessment and should not be adopted with haste.

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