Electricity Market Intervention

A review of the way Member States award subsidies for electricity generation is needed, says the European Commission. The aim will be to make public intervention in electricity markets more effective in providing secure and affordable energy for citizens and business. This and more was announced in a Communication published last week.
The Communication “Delivering the internal electricity market and making the most of public intervention” provides Member States with guidance on how national authorities can design capacity mechanisms in a cost-efficient way along with guidance on the reform of existing national support schemes for renewable energy in view of the expected ‘completion’ of the internal electricity market by 2014.

The instructions provided in the Communication follow on from the Commission’s 2012 Internal Market Action Plan for Europe and as a response to the European Council’s call in May 2013.

The outcome of the public discussion launched by the new Communication will inform a new set of Guidelines on Energy and Environmental Aid for 2014-2020.

A New Role for Public Intervention in the Electricity Market

According to the Commission, Member States can use the opportunities offered by the internal electricity market only if a strong regulatory framework at EU level exists..
The Commission considers that the role of public intervention in energy has been redefined as the market has developed. Yet state intervention is very important to secure a level playing field, correct market failures and foster new technology. Therefore public intervention may be justified in the following circumstances:

Financing new Renewable Energy Sources (RES) Technology

Support schemes should be adapted to the current situation, where RES electricity has a significant market share of 13% of EU final consumption (2011). New support schemes should thus focus on the development of more performing future renewables;

Response on the Demand Side:

 The Commission believes that electricity users could play an influential role in the energy market and contribute to the flexibility of energy networks via changes in both consumption patterns and energy supply. This opportunity is possible through new technological developments such as smart distribution networks, smart meters and electricity storages;

Combatting Climate Change:

 Public intervention in electricity markets is essential for internalise environmental costs and reduce Co2 emissions. Member States should proceed on the phasing-out of subsidies to fossil sources (amounting to 26 billion euros in 2011), while some of them consider necessary to grant state aid for investment in nuclear generation (35 billion euros in 2011) in addition to RES support scheme;

Generation Capacity:

 State intervention may be needed to ensure the stability of electricity production systems, due to the diversification of sources of generation and the increased share from RES. When Member States invest in new electricity generation capacity or remunerate existing plans to remain operational, they should ensure that public interventions result in efficient measures.

Making Public Intervention More Effective

The Commission believes that well-designed and coordinated public intervention could lead to achieving policy objectives on energy and climate change without distorting competition in an interdependent electricity market. The Commission provides a number of suggestions for Member States on how public intervention could be effective in this respect:

1) Member States can decide to intervene once the specific problem is identified and could not be solved through the application of EU acquis and the means offered by the internal electricity market. This is the case when for example market barriers hamper the development of new renewables technology; 

2) It is crucial for Member States to ensure coordination with other energy policy objectives when planning public intervention, in order to avoid conflicts (e.g. supply vs. environmental goals); 

3) Member States are invited to explore other alternatives to public intervention, which can be offered by EU policies and programmes. For instance, they could promote long-term contracts for constructing new power plants between generators and future consumers, without prejudice for the application of competition law. Another option is to disclose the potential of the demand-side response; 

4) Despite the harmonisation at EU level of rules regarding network access for electricity suppliers, national rules that are not harmonised should not discriminate across technologies and not exempt any generators from their financial responsibility for network development; 

5) As for the form of intervention, the Commission requires Member States to apply the proportionality test when planning public intervention (this must be appropriate to the objective and not go beyond what is necessary to achieve it). Moreover, Member States should plan support schemes across different technologies and then leave it to the market to select the most efficient among them; 

6) Finally, the Commission considers that public intervention should be phase-out once the circumstances that have justified them change or cease to exist. In this respect, a regular evaluation carried out by competent authorities is necessary. 

Principles for Designing ‘Generation Capacity’ Mechanisms

The creation of an internal electricity market characterised by diversified sources of production, several producers and separate network operators poses a major challenge both generally for an economy moving towards decarbonisation and specifically for the reliability of the electricity system. In this context, the role of public authorities in monitoring and ensuring security of supply has thus become more important.

The Commission sets out in the Communication and accompanying Staff Working Document on ‘generation adequacy’ a number of principles on how security of supply can be guaranteed in the internal electricity market.

Assessment of ‘Generation Adequacy’

When doubts arise as to whether the market delivers ‘generation adequacy’ and before any public intervention, competent authorities should carry out an objective, fact-based, and comprehensive assessment of ‘generation adequacy’ and notify it to the Commission. The assessment should take into account the EU policies on energy and on environment, the cross-border dimension of electricity markets, consultations with stakeholders, data on the development of variable wind and solar, the potential for demand side management.

If this assessment reveals a problem concerning ‘generation adequacy’ exists, Member States are asked to evaluate alternative measures to minimise or solve the problem, e.g. the promotion and enabling of demand response. The causes of ‘generation inadequacy’ and any distortions that may prevent the market from delivering the right incentives for investment in generation capacity (such as high subsidies for renewable energy or regulated prices - except social prices for vulnerable customers) must be properly identified and addressed.

Choice of Instrument

If alternative measures are insufficient to avoid the identified ‘generation adequacy’ concerns, the Commission suggests using instruments that cause the least distortion to the market, such as a strategic reserve or a credible one-off tendering procedure. In the Commission’s view these are easier to implement than market wide capacity mechanisms unless there is clear evidence that they are unsuited to filling the identified ‘adequacy’ gap. In any case, when choosing the mechanism Member States should take into account the objective of phasing out fossil fuel generation subsidies by 2020.

Design Features of Capacity Mechanisms

The Commission considers that mechanisms to ensure ‘generation adequacy’ should be open to all capacity which can effectively contribute to meeting the required ‘generation adequacy’ standard. The Staff Working Document illustrates some options in this respect, namely: 
• Open capacity mechanisms to demand side participation
• Consistency with decarbonisation objectives to avoid the lock in effect of new high carbon generation capacity
• Basing restrictions on participation in a mechanism to ensure ‘generation adequacy’ on the technical performance required to fill the identified ‘adequacy’ gap and not on predefined ‘technology types generation adequacy’.

The Commission also stresses the importance of cooperation between Member States in order to exploit the potential of implementing cross-border mechanisms. Moreover, it notes that there should be no export charges or procedures to reserve electricity for the domestic market and no bidding restrictions.

How to Finance Support for Capacity

The Commission invites Member States to undertake a detailed cost benefit analysis, including a comparison of the alternatives, before deciding upon public interventions to support ‘generation adequacy’. According to the Staff Working Document, costs of capacity mechanisms should be should be allocated in a transparent and non-discriminatory manner to consumers in proportion to their contribution to demand during periods of scarcity or system stress. For instance, consumers, especially industry, who are able to manage their demand flexibly this could end up with them paying less towards the capacity mechanism.

Reforming Support Schemes for Renewables

The development of renewable forms of energy is a well-known an objective of the EU energy policy, particularly in the fight against climate change. Due to market failures, public intervention is traditionally necessary to stimulate private initiatives to provide the optimal level of renewables. Intervention can take the form of state aid to certain sectors or companies (grants or tax exemptions) or the imposition of public service obligations.

However, as technology develops and investment costs fall, many Member States have started a reform of their support schemes for renewables. The Commission believes that financial support should only be granted when it is necessary to make renewables more competitive. Therefore new renewables support schemes should aim at creating stable conditions for investment and facilitating the integration of RES electricity in the internal electricity market.

Choice of Instrument of Support

According to the Communication, support schemes should be designed in a flexible way so as to respond to falling production costs. As they develop, subsidised technologies should be gradually exposed to market prices and eventually support must be fully removed. If support is still necessary it should supplement market prices, not replace them, and be limited to the minimum. The Commission suggests a number of alternative support schemes:

1) Moving from feed-in tariffs (where producers receive a fixed price per kWh independently of the market price) to feed-in premiums (producers are paid a market price plus a premium); 

2) Support instruments such as quota obligations are also considered: here energy suppliers have to ensure that a certain share/quota of the electricity they supply comes from renewable or green certificates. The price of the renewable energy is a market price; 

3) Another possibility is that Member States auction a certain capacity of renewable energy production, thus revealing the costs of the different technologies. This would foster competition among different producers and different RES and reward the most cost-effective projects; 

4) To maximise competition “local content rules” (requirements for particular energy feedstock or equipment to come from a given area) introduced by Member States on support schemes regarding the origin of the upstream components of energy should be removed. 

Regulatory Framework

The Commission considers that the effectiveness of support schemes also depends on the elaboration of a coherent policy framework. Support schemes should be part of a long-term predictable and stable framework with clear objectives.

Consequently, Member States should avoid introducing unannounced or retroactive changes to the support schemes, in order to respect investors' legitimate expectations concerning the returns on investments made.

Europeanization of Support for Renewables

The Staff Working Document on the reform of support schemes highlights the importance of a better coordination among Member States in developing their renewable energy policies. This could be achieved through several practices: convergence of common methodologies, reduction of restrictions for cross border access, cooperation mechanisms provided by Directive 2009/28 (such as the acceptance of energy supply from other Member States in national support), a common methodology for calculating costs.

Next Steps

The Commission will discuss with Member States how the principles set out in this Communication can be applied in practice. The results this debate will be taken into account in the adoption of the Guidelines on energy and environmental aid 2014-2020. A public consultation on the draft text of the new guidelines will be launched before the end of 2013, while the adoption is scheduled for the first half of 2014.