The time for member states to pull together and address Europe's need for greater energy security has never been better, writes Stephen Woodhouse.
The two driving objectives underlying European integration have historically been economic benefits and security. There is much to be gained on the energy front for precisely these two reasons as well.
A coordinated energy system, currently lagging behind integration in other areas, has a great deal of benefits for member-states in terms of interconnection, efficiency and better overall management. Indeed this is exactly what the Vice-President designate for Energy Union Maroš Šefčovič told MEPs in October of last year.
Electricity market integration also has the opportunity to develop greater security of supply during a time of geopolitical fears about supplies from Russia, which Šefčovič highlights, and when changing fuel mixes are putting energy security back on the agenda for domestic supplies. Traditionally, new generating capacity was built assuming near-baseload (24-7-365) operation.
Recognising the importance of security of supply to individual states and the national inclination to implement a local solution, Capacity Remuneration Mechanisms (‘CRMs’), are now being implemented in several European countries and seriously debated in many others.
CRMs are simply mechanisms designed to reward capacity independently from the delivery of energy. The issue with capacity markets however is that they tend to bring centralisation and policy risk, and risk destroying the price volatility which allows efficient demand side response and flows between neighbouring price areas.
Since the above CRMs are nationally‑based, each is different in design, and they have no arrangements yet in place for cross-border participation.
So while energy markets are gradually integrating, capacity markets represent a divergence that could undermine the Internal Market for Electricity. Uncoordinated CRMs risk distorting spot electricity prices, especially over critical peak periods, and by extension may distort cross-border electricity trading and investments as well as damaging demand side response.
CRMs should not stand in the way of creating ‘smarter’ electricity markets with a more active role from the demand side. They should work with minimal distortions even at boundaries between markets with and without a CRM.
A common CRM blueprint, which allows a wide degree of freedom for changing design parameters to meet national needs, without causing distortions between markets, and requiring any country to adopt a CRM, could be beneficial.
Reliability options as implemented in New England, Colombia and proposed in Italy and Ireland, partially address these concerns but still place strong reliance on central bodies to define the physical characteristics of the contracted capacity, and the commercial terms of the contracts.
Decentralised reliability options is a new concept which allows key parameters to be decided by buyers and sellers, including the strike price for the options, the option expiry time and the contract duration.
As a result, the market value for different classes of capacity will reflect its flexibility and alter according to the system needs, without regulatory intervention. Ultimately, the scheme could be transitional as a path to an enhanced energy only market which combines options and forward contracts to hedge price and volume risk.
This would amount to a more efficient and resourceful way to address the capacity issue facing member-states. There are various schemes and models around the world which member-states can learn from and which can constitute a useful starting off point for developing a model that works best for Europe.
The capacity issue is one that is only going to grow in the future as security and reliability of supply becomes more uncertain. The time for member states to pull together and address a common problem collectively has therefore never been better.
Stephen Woodhouse is director at Pöyry Management Consulting.