26th September 2013

Making the internal electricity market work

by Georg Zachmann on 26th September 2013

This article was first published in European Voice.

Why the economic pressure to create a comprehensive internal energy market is building

It is almost impossible to find a European policy-maker who does not want a well-functioning internal energy market. And at first glance, the internal energy market does seem to be on track. In 2012, French and German power plants obtained the same hourly price for the electricity they sell 64% of the time.

Regulators and network companies are working at full steam to harmonise complex technical rules for cross-border electricity exchange. Co-ordination of the operation and planning of networks has substantially increased. So, completing the internal energy market next year – the ambitious political deadline set by European Union heads of state – seems feasible.

But all is not as it seems. Twenty years ago, the joint energy wholesale market was at the heart of the internal market agenda. This was sensible because competition between conventional power plants across Europe would improve operational efficiency, mean that consumers could be served by fewer plants and would reduce operators‘ ability to levy excessive prices.

But the energy landscape has changed dramatically. In 2012, 64% of newly installed EU electricity generation capacity was either wind or solar. The massive deployment of renewables makes electricity worthless when the zero-cost production from these sources exceeds the demand. In some countries, this is happening increasingly frequently with the deployment of renewables. As a result, in the second quarter of 2013, average wholesale prices in Germany, France, Austria and Switzerland fell below €0.03 per kilowatt hour (kWh), while domestic consumers in Germany continue to pay about €0.25/kWh.

At the same time, the value is increasing of more robust networks, flexible power generation capacity (for example gas turbines) that can quickly ramp up when renewables production is below expectation, and the capacity to produce electricity when demand is high and renewables production is low. The pricing of renewables, and remuneration for network availability, flexibility and capacity remains, however, organised nationally. National remuneration schemes have in many cases become less compatible. For example, capacity in France and Germany used to be remunerated through the wholesale price only. Now, France is putting in place a general mechanism to remunerate all capacity in its territory, while Germany has introduced a ‘strategic reserve‘ that pays only for the capacities of selected power plants.

With incompatibility on the rise, the role of wholesale markets is bound to vanish. Excess capacities and growing volumes of renewables that have no variable cost will cause the wholesale electricity price to converge towards zero. At the same time, electricity consumers will have to pay increasing levies and tariffs into the national schemes for remunerating networks, renewables, capacity and flexibility that are outside the internal market. Thus, the completion of the internal wholesale electricity market could be a hollow victory.

Internal energy market policy has to take this dramatic shift into account. A market design that remunerates bulk electricity, renewables, networks, flexibility and capacity consistently in all countries is the prerequisite for making the internal electricity market work. Coherent network planning is in the European public interest and should be organised and financed accordingly.

In a study for the European Parliament, we showed that the benefits of deep integration can be substantial. A comprehensive internal market in which the conventional power plant fleets is optimised on the EU level, instead of nationally, can reduce the total system cost by 5%-10%. The benefits will be even greater if the roll-out of renewables, the provision of flexibility and network investments is optimised in a co-ordinated way.

So far, vested interests and concerns about national sovereignty have stalled the completion of the internal energy market. But, because the benefits of deep co-operation increase with the growing share of renewable sources of energy, the economic pressure to create a comprehensive internal energy market is building.

Blueprint – ‚Electricity without borders: a plan to make the internal market work