Last week the European Commission got the ball rolling on what is going to be one of the ‘hottest’ topics on the EU energy agenda in 2023: a reform of the EU’s electricity market design. On 23 January, the EU’s executive launched a three-week public consultation on what the reform of the power market rules should prioritise. The consultation is meant to inform a legislative proposal that is pencilled in for March.

For several months since the energy price crisis broke out, Brussels was reluctant to make any changes to the bloc’s power market, despite facing tough criticism from mainly southern EU member states.

However, as high power prices persisted and the bloc’s capitals pressured Brussels to act, Commission President Ursula von der Leyen announced a “deep and comprehensive” electricity market design reform in her 2022 State of the European Union speech last September.

A reform of the EU electricity market design was announced by European Commission President Ursula von der Leyen in her annual State of the Union speech on 14 September 2022. (Photo by Christophe Licoppe; European Union, 2022)

This sudden U-turn has forced European governments, companies, industry associations and civil society alike to quickly find their positions in this debate.

EU lawmakers and national diplomats are bracing for months of tough talks. While some EU capitals have been very vocal in favour of the reform, other – mainly northern – member states are reluctant to meddle too much with the market’s current functioning, arguing that it is delivering a significant amount of investments in renewables.

The energy sector itself has shown scepticism and even concern about the sudden announcement of a major reform, fearing that any rushed proposal without proper assessment of its implications could erode investor confidence in the sector as a whole.

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“We must avoid radical and disruptive changes because that would scare off investors,” says Kristian Ruby, secretary-general at European electricity trade association Eurelectric. “We need, if anything, an evolutionary approach that allows for continued confidence in the market, and a continued understanding of what the market rules are.”

Two separate debates

The EU electricity market design reform intends to answer two main questions: how to protect consumers from external price shocks, and how to ensure investors get the long-term signals to continue investing in renewables and demand-side management.

“The current regulatory framework […] has proven insufficient to protect large industrial consumers, SMEs and households from excessive volatility and higher energy bills,” the Commission said in a short note accompanying its public consultation.

It added: “Any regulatory intervention in the electricity market design […] needs to preserve and enhance the incentives for investments and provide investors with certainty and predictability, while addressing the economic and social concerns related to high energy prices.”

In the last reform to the EU’s electricity market design, concluded in late 2018 as part of the Clean Energy for All Europeans package, European energy experts already flagged the need to focus on attracting investment into long-term storage and clean energy technology.

“[The package] did not really address sector coupling, and it did not go deep into the demand side,” says Matthias Buck, Europe director at Berlin-based think tank Agora Energiewende. “It was also clear in 2018 that we would have to reassess whether that package provided sufficiently reliable long-term investment signals to fully decarbonise Europe’s power system, consistent with the EU’s accelerated climate action.

“Currently, we are not discussing a deeper reform to enable fully decarbonised power systems but short-term crisis management measures to shield consumers and households from excessively high electricity retail prices […] and it is really important to distinguish those two different debates,” he adds.

The EU’s renewable energy industry fears that the two debates are being mixed up. “What we hope to see is really a focus […] on how we ensure long-term investment signals and how we bring the value of renewables closer to consumers,” Naomi Chevillard, head of regulatory affairs at the solar PV trade association SolarPower Europe, told Energy Monitor.

A revolution from the south

Some of the governments that are most in favour of a wide-ranging reform of the EU’s electricity market design have already put their support in writing. A first position paper from Greece in July 2022 was followed by a Spanish paper in mid-December and a French so-called ‘non-paper’ earlier this year.

The energy industry has pushed back on Madrid’s views in particular. Spain attributes the current volatility of energy prices to several “market failures” – it cites the gas supply shortage as well as limited hydropower production as a result of recent droughts – and proposes a new pricing model based on long-term contractual arrangements such as power purchase agreements (PPAs) or contracts for difference (CfDs) negotiated by an independent regulator at national level.

However, experts have pointed out that several of the market failures Spain refers to are supply-side issues that a reform of the wholesale electricity market design will do little to solve.

There have also been warnings around the risk of excessive centralisation of power purchasing by the state, which would distort the internal energy market, the industry warns.

“The problem with this approach is that you will have one centralised entity doing the investments and bringing it [power] to consumers,” said SolarPower Europe’s Chevillard. “In market models […] each consumer can have specific needs and each producer can propose specific innovative solutions.

“If you have the state buying and selling, then you have a national [electricity] price and lose the benefits of having interconnected markets and facilitating the transfer of electricity between countries,” she adds. “Thanks to our interconnected electricity grids, we have a more resilient grid in Europe than in the US, for instance."

Price caps and exceptions in a new EU electricity market design

Spain and Portugal were hard hit by the gas price spikes over the past year-and-a-half. As a result, these two countries adopted a mechanism to cap wholesale gas prices for electricity generation in an attempt to rein in increased risks of energy poverty.

The 'Iberian exception’ is currently in place until May this year, but both Lisbon and Madrid have suggested they may request the Commission to allow the mechanism to function until a new EU electricity market design is adopted. That is likely to be a while yet: negotiations between the EU institutions will probably take at least a year – and it might take another year for the 27 member states to transpose the legislation. So any changes to the market design will probably not kick in until at least 2025.

One of the issues that the new market design proposal may seek to address is the so-called ‘revenue cap’ of €180 per megawatt-hour that the EU adopted late last year, and whether this temporary measure should be extended. For now, the energy sector has warned that the cap has been applied inconsistently across EU member states, creating market distortions.

“We need a harmonised implementation [of the revenue cap] going forward if the instrument is continued, to avoid investor uncertainty and to ensure the needed investments into the build-up of renewables,” says Buck.

Bringing renewables closer to consumers

Governments and industry agree that the upcoming EU electricity market reform will need to explore how to translate the lower wholesale generation costs of renewables generation into cheaper retail energy costs for end consumers. In its public consultation, the Commission proposes two ways to do so: through PPAs between utilities and consumers, or through CfDs between utilities and governments.

“Power purchase agreements bring multiple benefits,” the document says. “For consumers, they provide cost competitive electricity and hedge against electricity price volatility. For renewable projects developers, they provide a source of stable long-term income. For governments, they provide an alternative avenue to the deployment of renewables without the need for public funding.”

However, the document adds that, while the role of PPAs is increasing, their overall market share remains limited, their growth is concentrated in some EU member states and it is limited to large companies. A reform of the EU electricity design could provide customers with “better opportunities and more choices” to mix short and long-term price signals, Eurelectric says. It could, for instance, allow a customer who is 100% exposed to the spot market to choose to have a certain share of its electricity secured at a certain fixed price.

“Until recently, the philosophy of the legislator was that the short-term market provides the cleanest and most transparent and reflective price,” says Eurelectric’s Ruby. “What this crisis has shown us – and what we have been seeing as an industry for a long time – is that the energy transition is about longer-term arrangements, and we should also make sure that these longer-term arrangements are possible for retail customers to enter.”

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The European Consumer Organisation (BEUC) sees an opportunity for a reformed EU electricity market design to introduce new provisions related to consumers rights, such as protecting vulnerable households from being disconnected from the grid if they are unable to pay their bills for a period of time, and avoiding unilateral price increases by utilities.

The current legislation allows energy suppliers to unilaterally increase electricity prices as long as they notify consumers at least 30 days in advance, and allow consumers to terminate the contract free of charge. However, when energy prices are high, switching to a new electricity provider is likely to force a consumer to agree to a new, more expensive energy contract anyway. In Italy, the national competition authority is investigating an alleged unilateral price increase in the fixed contracts of some seven million households – after Rome temporarily banned the practice to protect consumers from the energy crisis.

"Unilateral price increases should be banned under the new directive,” says Jaume Loffredo, team leader for energy at the BEUC. “When consumers take out a fixed price contract they expect the price to stay the same for the entire duration of that contract.”