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7 EU Electricity Market 2020 and the environment

The European Single Market in Electricity: An Economic Assessment Pollitt, M.G. Rev Ind Organ (2019) 55: 63. https://doi.org/10.1007/s11151-019-09682-w

Monday 30 October 2023, by Carlos San Juan


The European single market in electricity has been promoted vigorously by the European Commission since 1996. We discuss how national electricity markets and cross-border electricity markets have been reshaped by the process. We examine the Commission’s own work on evaluating the benefits of the single market. We look at the wider evidence of impact on prices, security of supply, the environment, and innovation. We conclude that the institutional changes are extensive and there has been significant market harmonisation and integration. However, the measured benefits are difficult to identify, but likely to be small. This is partly because over the same period there has been a large rise in subsidised renewable generation that is driven by the decarbonisation agenda.

L-7 EU Electricity Market 2020 and the environment

SLIDES

The Economics behind the Spanish RRP By Carlos Maravall. Comisión Europea. D. G. Energía. UC3M. 2023

COMPULSORY READING

The European Single Market in Electricity: An Economic Assessment.

by Pollitt, M.G. Rev Ind Organ (2019) 55: 63.

Extended abstract for UC3M students use only:

The overall context for current energy and climate policy to 2020 is the targets for 2020 that were agreed upon in 2007 and were enacted in 2009:

1) a 20% reduction in CO2 (from 1990 levels);

2) 20% of gross final energy consumption to come from renewable energy11; and a

3) 20% increase in energy efficiency (energy demand relative to levels projected around 2005).

The European Union agreed in 2014 to set a 40-30 set of targets for 2030 more precisely:

1) 40% greenhouse gas (GHG) emissions reduction;

2) 27% renewable energy quota of total primary energy; and

3) A 30% increase in energy efficiency), with priority given to the 40% reduction in greenhouse gas emissions.

The EU-wide targets for CO2e (e meaning equivalents to CO2 Tm) reduction and renewables share are disaggregated into national-level targets (some greater or less than the aggregate target). In contrast, all member states are expected to meet the energy efficiency target.

These targets are themselves in the process of further tightening at the COP28 at the end of 2023

2 The Evolution of the Single Market in Electricity

The individual member states of the EU single market have very different national electricity resources: Germany, France, the UK, Italy, and Spain have large national markets significantly larger than other countries.

1) France is dominated by nuclear;

2) Germany has a significant share of coal;

3) while the UK, Spain, and Italy have relatively more gas in their electricity mix.

4) Norway has significant hydro capacity.

5) Many other national markets are small but located close to much larger countries (15). This immediately suggests that there must be significant room for trading to exploit relative price differentials from the different marginal generation technologies, non-coincident peaks in demand, and the sharing of reserve capacity.

The energy sector inquiry

Published its final report in January 2007. It found that there were:

1) too much market concentration in most national markets;

2) a lack of liquidity, preventing successful new entry;

3) too little integration between Member States’ markets;

4) an absence of transparently available market information, leading to distrust in the pricing mechanisms;

5) an inadequate current level of unbundling between network and supply interests, which has negative repercussions on market functioning and investment incentives;

Explaining UNBLUNDING

VIDEO: Third Package of Internal Energy Market Legislation - Part 2 by Leigh Hancher

6) customers being tied to suppliers through long-term downstream contracts;

7) current balancing markets and small balancing zones which favour incumbents (meaning traditional operators, see the video for an explanation)

VIDEO: European Union Energy Market Liberalisation

The inquiry led to a number of recommendations, including competition enforcement action where necessary:

1.- the unbundling of transmission network ownership from generation; increased powers for regulators;

2.- increased cross-border regulatory coordination; improved market transparency;

3.- removal of regulated retail tariffs;

4.- and competitive allocation of cross-border interconnector capacity.21

The Energy Inquiry was a significant driver behind the Third Energy Package, which gave rise to

1) the 3rd Single Electricity Market directive in 2009 and

2) the creation of the pan-European regulatory agency (ACER).

VIDEO: The Agency for the Cooperation of Energy Regulators ACER by Alberto Pototschnig 30 Sept. 2013

3) Transparency has been increased by the 2011 REMIT Regulation (No. 1227/2011), which covers oversight of interconnectors and abuse of markets and is overseen by ACER.

VIDEO: The new EU Regulation REMIT by Alberto Pototschnig

A further observation is that wholesale prices remain subject to commodity price fluctuations for both gas and coal. 2008 to 2012 was a period of falling commodity prices; by contrast,2004 to 2008 was a period of significantly increased commodity prices. Figure 1 shows the underlying rise in nominal commodity prices for coal and gas in Europe over the period we are considering and the large fluctuations that have occurred.

Open the image in a new window. Fig. 1 Nominal index of coal and gas prices: 1999 to 2016. Source: BP (2017)

It is interesting to compare electricity prices in Europe with the US. US prices are lower, but over the long run, EU prices show no convergence with them. Figure 2 shows the evolution of industrial electricity prices in Europe versus the US. While prices converged a little in nominal terms to around 2001, the ratio of the EU/US industrial electricity prices in Euros has increased from around 2 in 1991 to 2.3 in 2016.

Open the image in a new window. Fig. 2 Industrial electricity price per kWh (Exchange rates from ofx.com). Source: US EIA and Eurostat data

Figure 3 shows the evolution of residential electricity prices in Europe versus the US. While prices converged a little in nominal terms to around 2001, the ratio of the EU/US residential electricity prices in Euros has increased from around 1.7 in 1991 to 1.8 in 2016.

Open the image in a new window. Fig. 3 Residential price per kWh (Exchange rates from ofx.com). Source: US EIA and Eurostat data

The impact of the single market on aggregate prices and welfare since 1999 is difficult to ascertain —as the above charts suggest.

According to Eurostat figures I, in 1991, 18% of the industrial price of electricity was taxes and levies; by 2016 t, it had risen to 43%. For households, the comparable figures were 15% in 1991 and 36% in 2016.

Thus, pre-tax and pre-levies electricity prices for industry and households have risen only 6% and 20% (in nominal terms) in 25 years.

By contrast, the Euro area CPI rose b2% between 1996 and 2016.

This suggests significant decreases in the real pre-tax and pre-levy prices of electricity in Europe over the period.

4.5 Environmental Impact

The European electricity system has experienced a profound transition concerning environmental impact.

Between 2004 and 2016, the share of electricity generation from renewable sources has doubled from 14.3 to 29.6%. Hydroelectricity has barely changed in absolute quantity over this period.

The increase is almost entirely due to an increase in wind, solar, biofuels, and other renewables; total generation has fallen by around 1%.

The emissions intensity and energy efficiency of EU electricity have also improved significantly.

1.- What is certainly true is that a combination of market liberalization (which initially favoured gas over coal),

2.- carbon pricing (which also favours gas over coal), the

3.- Large Combustion Plant Directive (which forced higher emissions standards on existing and new coal-fired power plants and raised their costs), and

4.- renewables support policies (which have led to renewables increasingly reducing wholesale electricity prices for both coal- and gas-fired power plants) have largely ended the building of new coal-fired power plants in the EU (see Caldecott et al. 2017).

However, public dissatisfaction with liberalised energy markets in Europe remains strong.

What is more clear is that public dissatisfaction with liberalised energy markets in Europe remains strong. Fiorio and Florio (2011) showed that private ownership of electricity assets was correlated with increased public dissatisfaction with the industry in Europe.

This dissatisfaction explains the remaining significant public ownership in European electricity despite the single electricity market and the fact that in at least half of EU countries, residential price controls still exist for some household customers:

Something that ACER continues to condemn as limiting the impact of the single-market project.

VIDEO: Alberto Pototschnig | Electricity Markets: The Wholesale Markets

5 Conclusions

If one reflects on the development of the EU single market in electricity, it is difficult not to be impressed with it in terms of the structural changes since 1996. National markets, once dominated by a single incumbent generator and a single incumbent retailer, have been opened to competition. Independent regulation has been significantly increased, both at the national and at the level of the EU itself.

There has been significant enforcement action by the European Commission’s competition authority (DG Competition) to promote further reform. Legislation has evolved through successor directives, and a new directive is under discussion (as of late 2018).

In parallel, there has been the development of power exchanges and market coupling, as well as the emergence of non-discriminatory access to the transmission system with robust legal and ownership unbundling of transmission and increased coordination between national system operators.

The ownership of the industry has been reorganized, with large numbers of pan-European mergers and acquisitions and the entry of gas incumbents into electricity.

Cross-border trading of electricity has increased.

There has been a high degree of regulatory convergence in electricity among member states at a higher level than might have been imagined in the absence of the single market.

At the same time, the environmental agenda has been promoted with the introduction of a carbon market in 2005 and massive financial support for renewables which have significantly affected prices which is bringing about a genuine energy transition.

The electricity industry has been transformed, especially for countries with less favourable initial attitudes to competition in electricity.

However, while the level of structural and institutional change is impressive, the quantification of the costs and benefits of the single market is extremely hard.

The evidence that we do have suggests that the overall gains in terms of price, cost, and quality of service impacts are modest e, especially if we consider the 25-year time frame.

Based on the available evidence, one can say that the overall impacts on welfare would seem to be small.

The evidence indicates some slight productivity improvement, some wholesale price convergence, and limited (if any) retail price reductions.

Single electricity market remains a work in progress

The Commission and its sector regulatory organisations (ACER and the CEER) s stress that more needs to be done. The fourth energy package is a commitment to doing more. Indeed, one of the genuinely good reasons that the Commission may not have emphasized studies of past gains from the process is precisely to keep the focus on what needs to be done in the future.

Another more ambiguous reason for the Commission’s reluctance may be the desire not to draw attention to the cost of European climate policy, which has been significantly borne by European electricity consumers.

Careful analysis will likely draw attention to the apparent fact that much, if not all of the gain from the single electricity market has been spent on climate policy.

Discussion

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