Are we on the verge of an energy market revolution?

Impact of the energy crisis

There were multiple reasons behind the recent energy crisis, like dependence on Russia, high gas and coal prices, and the unavailability of nuclear and hydro power plants in some EU countries. Against this backdrop, the market became a scapegoat.

The design of the future energy market will be crucial for companies like PGE Polska Grupa Energetyczna S.A. - the main Polish power and heating producer - which invests heavily in clean technologies (like offshore wind farms and PVs) and the replacement of its existing coal-based CHP assets in line with the EU Taxonomy. By 2030 the PGE Group intends to build 2.5 GW of new capacity in offshore wind farms, 3 GW in photovoltaics and expand its onshore wind farm portfolio by at least 1 GW. The total estimated CAPEX by 2030 will reach at least 17 billion euros.

Reliable and stable market rules are vital to make it happen. Therefore, any significant changes to the market design need to be carefully considered.

“The energy crisis has demonstrated the resilience and benefits of the integrated European market and highlighted the need for long-term arrangements to support investment in clean technologies and to provide more hedging opportunities to consumers” says Fabien Roques, Executive Vice President & Head of Energy Practice in Compass Lexecon.

In this political climate and amid numerous conflicting demands, in March 2023 the European Commission produced a proposal for a reform of the EU power market design.

Support from stakeholders

Work on the market design proposal is to be concluded this year. Business representatives are concerned about the lack of proper impact assessment, as the reform could determine the market for several years to come.

This is likely why Prof. Leonardo Meeus, Director of the Florence School of Regulation, describes the proposal as “remarkably balanced.”

“Electricity markets are complex, so it was worrying that the Commission had to produce a reform proposal in a record time frame during a crisis," says Prof. Meeus. “It is impressive that they have been able to draft a significant proposal that addresses the main issues. It is also a relief that the more radical proposals that circulated after the peak of the energy crisis last summer, have not been picked up.”

Within the electricity sector there is a broad consensus that temporary measures like the "revenue cap" introduced by EU member states should not become permanent. Without profits, the power sector cannot continue decarbonisation investments.

How to secure future-proof investments?

The two-way contracts for difference (CfDs) have proven to be key to renewables. They reconcile two objectives: ensuring the predictability of prices for consumers and helping to finance new investments.

“Two-sided CfDs have been a good model to ensure revenue stabilisation. They have a proven track record in many European countries. Under a two-sided CfD, governments don’t only pay out, they also get paid back when the electricity price is higher than the CfD price. The perspective of stable revenues also allows investors to minimise their financing costs. But CfDs are no panacea. The Commission has done the right thing, allowing operators to also sell their power under a Power-Purchase Agreements (PPA) or to go fully merchant”, says WindEurope CEO Giles Dickson.

However, many other stakeholders are of the opinion that there should not be any form of obligatory CfD for existing or new inframarginal units.

“Right now we need to find a right balance between consumers protection and need to deliver capital-consuming investments and we believe that EC’s proposal on market design is a good starting point of those considerations since it acknowledges the role of CfDs and opportunities, which gives the future PPA market,” says Wojciech Dąbrowski, CEO of PGE Polska Grupa Energetyczna S.A.

The price provided by CfDs should be dynamically adjusted and indexed not only to inflation but also to changing market realities, where the costs of labour, capital and manufacturing have been increasing at the fastest pace witnessed in the last couple of decades.

The proposal to redistribute potential revenues from CfDs among consumers - on the basis of their consumption might be counterproductive for two reasons. Firstly, it does not create incentives to reduce demand in times of energy scarcity and limited supply of primary energy carriers. Secondly, revenues from this form of support should be channelled to finance investments in grids and energy storage. The idea is to give to consumers a “rod” rather than a “fish''.

The second way of securing investments is to increase the number of PPAs. From the investor’s point of view this form of long-term commitments should be backed by the state. This is one of the developments of the proposal which will be welcomed by many. However, because of the relatively low-application of the PPAs it would be premature to require energy suppliers to hedge their supply on the basis of PPAs.

Now the Parliament and Council will have to agree on details of the reform shaping the final legislation during the inter-institutional negotiations, which will have to be finalised before the parliamentary elections next Spring. Policymakers will have to carefully balance the interests of citizens and companies alike, where the EU’s two main political objectives are at stake. On the one hand, they have to ensure low electricity prices. On the other hand, they need to facilitate accelerated transformation of the energy sector, which needs to help the EU cut its GHG emissions by at least 55% and reach 42.5% renewable target by 2030. This joint effort will require a policy framework that can deliver billions of Euros in investments across Europe, and more importantly, in Member States with different starting points.