On 30 November 2016, the European Commission released the latest legislative initiative in the energy field entitled “Clean Energy for all Europeans”. It aims to make the energy transition efficient, smooth and engaging. Its core resides in the Winter Package, which addresses the electricity markets, the renewable energy markets and the energy efficiency issue. How efficient is the EU in integrating national energy markets while trying to provide cleaner energy for tomorrow’s and today’s consumers?
The greatest challenge lies in integrating renewables into the electricity system in order to stimulate huge investments without disrupting the entire system. In particular, the Winter Package tries to define a European framework that addresses current malfunctions, so as to avoid that national decisions obstruct the European vision of the electricity market.
Despite the fact that energy is a shared competence, the choice of the energy supply relies exclusively on Member States. As a consequence, we have different national energy mix choices that prevent a functional cross-border cooperation, essential for an integrated European energy market. The aim of this article is to assess whether Europe is going to the right direction in making renewable electricity a key sector for the economic recovery and future development of Europe.
The European Union Scenario
The European Union is moving toward a clean energy scenario because it strives to reduce greenhouse gas emissions and to comply with the commitments undertaken under the worldwide Paris Agreement on climate change from 2015.
The European Union, with its advanced policies in the energy and environmental fields, has always been at the global forefront in the clean energy transition. In particular, with the 20/20/20 climate and energy package and the emission trading scheme legislation, the EU has set legislative cornerstones in fighting climate change.
The Future Policies
A more recent one is the so-called Winter Package, a set of legislations which modifies the previous electricity and renewables legislation. Its main purpose is to spread the potential of clean energy, making it “the growth sector of the future.”
Huge amounts of investments are required in order to reach that goal; their cost is estimated by the European Commission to be around “379 billion of euros” each year over the 2020-2030 period. To reach them, the EU has devised instruments such as the European Fund for Strategic Investments and the European Structural and Investment funds.
However, private investments are also necessary, but the current scenario prevents a clear prediction of the electricity price, which is not ultimately driven by market forces but by State subsidies. To put it shortly: this is not a suitable framework for long-term investments in the renewable electricity sector.
The EU energy dependency
These investments are required not only to shift toward a clean energy economy. Indeed, the EU has never been energy self-sufficient. The EU is deeply dependent in importing fossil fuels, in particular gas from Russia and oil from third countries. As acknowledged by the European Commission, in a document of 2014 entitled EU energy markets in 2014, “the EU is the world’s largest energy importer. The majority of Member States are highly dependent on imports of oil and gas. A few Member States have significant production that makes a considerable contribution to the European energy balance. “
Ultimately, this situation has determined high prices for final consumers and serious problems of supplies when geopolitical issues arose, as it happened during the Russia-Ukraine crisis of 2006 and 2009 or, looking back in the past, during the oil crisis in the 70s.
The Deployment of Renewables
The EU’s interest in renewable energies is not new. After the Chernobyl disaster in 1986, nuclear energy was not anymore considered safe enough to be produced; as a consequence, the EU pushed for a strong deployment of renewables. Since then, its production has continued to grow consistently.
In 2008, through the release of the 20/20/20 package in energy and climate change, the EU made a big step forward in making binding the achievement of the reduction of greenhouse gases by 20%, the rise in the share of renewables to 20%, and the increase of energy efficiency by 20% before 2020.
As far as renewables are concerned, each Member State must comply with its national binding targets. So far, these measures seem to work. According to Eurostat, “in 2015, the share of energy from renewable sources in gross final consumption of energy reached 16.7% in the European Union, nearly double from 2004 (8.5%).”
However, due to the fact that the final decision on energy supplies relies on Member States, this growth has not been uniform across the EU.
Some States such as Poland still strongly relies on fossil fuels production and its coal power plants while others, such as Germany, have a virtual ability to rely on 100% of renewables. While 11 out of 28 Member States have already achieved their targets, others continue to struggle.
The Third Renewable Energy Sources Directive
To tackle these differences, the Winter Package repeals the second Renewable Energy Sources (RES) Directive, with the so-called third RES Directive, establishing that a binding EU target of at least 27% for renewables should be reached by 2030.
The EU target gets rid of national targets in order to support cooperation, cross-border participation, and the reduction of subsidies. Indeed, subsidies are ultimately preventing an appropriate price formation. Subsidies make prices not driven by market forces, but a result of political choices pursued through administrative measures.
The third RES Directive pushed for a more market-centered approach, getting rid of administrative tariffs such as feed-in tariffs (offering long-term contracts to renewable energy producers) and pushing for a more market-oriented approach driven by a feed-in premium (fix tariffs plus a premium).
To integrate Renewables into the grid however, getting rid of subsidies is not sufficient; there is an essential need to redefine the electricity markets to make them suitable for renewables. This is why the Winter Package also repeals the third electricity package concerning electricity markets, to make them more suitable for renewables.
The Electricity Markets
In the past, the electricity markets were State monopolies, which gradually started to open to different competitors in order to increase its efficiency and decrease retail prices for final consumers.
To reach that goal, unbundling rules, i.e. the separation of vertical integrated structures, as owned by big electricity producers like the Italian electricity company Enel, were introduced. Unbundling, as a part of the internal market rules, is the effective separation of supply and production activities from network operations. Unbundling is meant to avoid monopolistic ownership of energy infrastructure as well as to create better functioning energy companies.
The European electricity market is the sum of the 28 national electricity markets, brought together by cross border cooperation. The final aim of the integration of the European electricity market is to get a unique European price for electricity. Right now, the price varies on a zonal basis. Moreover, the electricity flows from power plants to final consumers are produced through different sources: renewables and nuclear energy are considered clean energy sources, as opposed to coal, oil and gas which cause high emissions of greenhouse gas.
Old power plants based on coal need to be replaced or substituted in favour of cleaner production; this is also an issue to be addressed when taking into account the future electricity system.
Then, the electricity is transmitted to distributors, which sell electricity to consumers. The cross-border cooperation is ensured by the so-called “Transmission System”, which is usually a State monopoly. There are more than 300 000 km of power lines in Europe, including 355 cross-border lines. The production, transmission and distribution system in the electricity markets make the so-called “target model” which is the current model running in the EU.
The Target Model
This model was designed to support mainly the traditional European production based on fossil fuels and gas. Within the target model, the energy delivered is traded within four markets: day-ahead, intra-day, balancing power and forward markets. Currently, only the day-ahead market is functioning properly due the large number of players; the other three still need to increase their liquidity. Why is why energy is traded mainly on a day to day basis (in the day-ahead market) between seller and buyer, aiming at a delivery of energy for the following day.
The price is set through an auction, won by the last power plant necessary to satisfy demand according to the marginal price rules. This means that the power plant with the lower marginal cost is the one that wins the auction.
In economics, the marginal cost is the cost of producing an additional unit of output. In a market dominated by fossil fuels or traditional renewable power plants such as hydro, this system ensure that the least expensive plants are running at any time (the so-called merit order effect).
However, the increased share of renewables in the electricity production has caused some deep and structural changes in the functioning of the target models, because they do not face any marginal costs.
The Renewables Markets
Renewable markets are currently growing all around the world to meet the increasing demand of growing economies such as China and India and to achieve clean policies in developed countries such as Europe and USA.
In Europe, the production of electricity by renewable sources in 2015 was the same as the existing traditional generation capacity of 430 GW. Their consumption has constantly increased, with an average share of 16.7% of the final energy consumption in 2015; first in the cooling and heating systems, then in electricity and finally in the transport sector. Nevertheless, the share of renewable energies in transport is expected to increase and drive the spread of renewables, with the mass production of batteries for electric vehicles. The main issue is how to integrate renewable into the electricity grid without being disruptive for the system.
Electricity generated by renewable sources comes first into the grid because their “priority of dispatch” is guaranteed by the second renewable directive. Moreover, being dependent on weather conditions, renewable energy sources have zero marginal costs. Nevertheless, electricity pricing is constantly increasing. Why? Because renewables are constantly financed by subsidies, whose share in the final bill for consumers have constantly increased over the years. For all these reasons, market price signals are not reliable anymore and therefore, investments in this sector are stuck.
The main problem is that the supply and demand of electricity in the grid must always be balanced. To put it shortly: in order to avoid blackouts, there must always be electricity running in the cables. When the sun is not shining, or the wind is not blowing, especially during the peak demand, the risk of imbalance in the grid increases.
Putting a cap on electricity prices in order to stimulate power plants to produce electricity does not solve the issue of the future and constant increase of electricity from renewable sources into the grid. Ultimately, it is neither the more efficient nor an appropriate market-oriented way to deal with this situation. We face a paradoxical situation: State subsidies are vital on the one side to guarantee the functioning of the electricity market, but they prevent the investments necessary for its development.
The Winter Package
This situation is currently blocking the electricity market. To solve it, the European Commission has released the “Winter Package” at the end of 2016, which modifies the target model.
First, the reform addresses the demand-response issue and the necessity to better develop short-term electricity markets such as the intra-day and the balancing markets in order to deal with the peak load and base load scenarios.
Storing energy is another solution forecasted in the Winter Package. Until now, the pumped storage in the hydroelectricity sector has been the classical way to store energy. However, another possibility is storing energy using batteries. This technology is facing cost reduction thanks to the mass-scale production by companies like Tesla. However, European industries lag behind in the global competition of developing these innovative technologies.
The third option is developing a capacity mechanism, a sort of administrative measures that remunerate generators for the availability of resources. Since they have an impact on competition rules on the internal electricity market, they have to comply with State of Aid rules.
The Winter Package proposal sets principles for designing capacity mechanisms in line with the European regulation, avoiding distortion to competition and opening for cross-border cooperation. With this regard the most important thing is phasing out subsidies, however, for the moment this seems not feasible. This is why the Winter Package forecasts a gradual market-oriented approach, getting rid of the price cap and establishing a premium driven by market rules.
The Renewable Tariffs
To reach this goal, the Commission has upgraded the Environmental State of Aid Guidelines for the period until 2020. This document sets the rules that Member States have to comply with when they design financial support schemes.
As far as the cross-border cooperation mechanisms are concerned, these Guidelines do not set specific any binding rules; they state that support schemes should be open, without any binding commitment.
As a consequence, the final framework depicted by these Guidelines seems vague and fragmented, leaving much discretion to Member States, as far as the choice and the degree of openness of support schemes concern, which ultimately does not favour future investments. Hence, the question of how to better manage the tariffs of renewable energy sources in order to foster the integration of the European energy market remains opened.
A massive increase in energy supplies from renewable sources is to be expected for the next decades. Due to the fact that electricity markets are those with the biggest percentage of renewable production, the European Commission released the Winter Package in order to tackle some malfunctions which are currently blocking the electricity market.
These malfunctions have been caused by national support schemes for the deployment of renewables sources. However, they have now become unsustainable, because they distort the right market price formation, ultimately preventing investments in the electricity sector. This is why the Winter Package forecasts a shift from national regulation toward a market-oriented approach. It establishes a new framework for support schemes for the period after 2020 and, at the same time, reforms the electricity market to make it suitable for future challenges. One of the measures will be the integration of huge share of renewables, which will always be volatile and deeply dependent on weather conditions. As a consequence, flexibility is required and only a less rigid and discretional market approach can help to achieve these goals.
Only if a consistent number of Member States agrees on these changes will the EU be able to regain investors’ trust. Their trust is necessary for the achievement of the 2030 and 2050 de-carbonisation targets. To achieve them, a properly functioning electricity market is necessary and, in that sense, the Winter Package is going in the right direction by forecasting the proper adjustment of the electricity market in order to make the integration of renewable energy sources suitable and not disruptive.
The final aim remains to make the best use of both the technology and monetary potentiality to boost the EU economic growth in the future and to enable a smooth and efficient shift from a carbon-intensive to a low-carbon economy. This is the only way to create a strong and unique European Energy Union.
creedits illustration: FLICKR/EPSOS.DE
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LUCIA QUAGLIA is a graduate from the College of Europe Natolin in European interdisciplinary studies. She is specializing in the analysis of the renewable energy sector with a focus on the legislative initiatives undertaken by the EU to tackle the current bottlenecks and foster investment such as the Winter Package and the ETS reform.