Europe stands at a market design crossroad

The global energy crisis sparked by Russia’s illegal invasion of Ukraine shed light on a di cult problem: cheap clean electricity prices are being in ated by more expensive fossil fuels.

Decoupling a ordable renewables from costly gas-powered generation has become a top political priority as a result, prompting politicians to demand that market rules be changed so that energy systems can be insulated against future unforeseen global events.

Ideas on how actually to do that have ranged from the radical to the restrained as governments attempt to protect their national interests. Energy experts and the sector itself are sounding a note of caution though, insisting on evolution rather than revolution.

Radical Signals

The European Union (EU) is embarking on a reform process that was rather unthinkable at the start of 2022, given that top o cials had previously ruled out tinkering with the legislative architecture that underpins the whole market.

However, after months of increasing energy prices, protracted talks about capping gas prices and governments committing huge chunks of budgets to energy subsidies, this was one of the solutions that garnered political support.

“The EU electricity market system does not work anymore. We have to reform it. We have to adapt it to the new realities of dominant renewables,” European Commission President Ursula von der Leyen said in June 2022.

That u-turn and von der Leyen’s strong language suggested at the time that the Commission would propose a radical overhaul of the markets.

However, as price spikes attened out towards the end of 2022 and early 2023, and as political pressure waned, it became evident that rather than that radical overhaul, the EU executive branch would just propose targeted improvements to the current arrangements.

Muted Action

ACER, the EU’s energy regulators agency, carried out a full assessment in mid-2022 of how the market was

Route ahead

Regulators and lawmakers have to make a number of difficult choices to design an effective market functioning and found that the current design is t for purpose and “worth keeping”.

This was ultimately re ected in the Commission’s plan published in March 2023, in which it suggested that EU member countries should assess exibility (page 50) needs and set national targets for demand-side response (page 42) and energy storage (page 58.

Long-term contracts like power purchase agreements (PPAs) and contracts for di erence (CfDs) (page 32) will be made more attractive by market-based derisking guarantees. CfDs will only be mandatory if public money is involved.

More revolutionary changes to the rules will have to wait until the next Commission takes over in mid2024 after pan-European elections have been held in May of that year. The political makeup of the European institutions will then dictate how ambitious a full reform can be.

Governments and members of the current European Parliament are assessing the plan that is now on the table and will try to shoehorn their own suggestions into the mix before attempting to broker a nal deal before the end of 2023.

What the Commission says and what members of the European Parliament want only go so far, as the real weight of the decision will be imposed by the Council of 27 member countries, many of whom have voiced jarringly di erent demands.

Food For Thought

When the Commission launched its review, some governments wasted little time in outlining what they thought the reform should involve. Among those to propose more radical suggestions was Greece.

The Greek proposal said that the best way to shield cheap renewables from expensive gas prices would be to split the market into two separate pools based on the type of energy generation provided. Low-carbon and renewable energy sources would be grouped together and managed by state-backed CfDs, while on-demand resources would make up the other pool.

“It is evident that a market designed to apply marginal cost pricing does not t the purpose when the system is dominated by low carbon and zero marginal cost resources,” the proposal read.

“This leads to a systematic market failure: marginal costs persistently stay above total average costs and there is no way to make them converge, which is exactly what a well-functioning market must do,” the note added.