The war in Ukraine has triggered major policy changes. It has reshuffled the EU’s priorities and led to Europe rethinking its approach to energy and climate issues. The European Green Deal has become not only a strategy for achieving climate reduction targets but also a tool for ensuring energy security, strategic autonomy and boosting resilience to geopolitical shocks. The EU's energy market needs reform to ensure sustainable and affordable energy for all.
In this context, the European electricity market is now at a crossroads as the debate on its future design is kicking off. The wholesale market in the EU is a system of marginal pricing, whereby all electricity generators are equally remunerated for the power they are selling at a given moment. Electricity prices are set by the variable cost of the marginal plant, i.e. the most expensive plant that is required to serve demand. The current market design has come under scrutiny as energy prices skyrocketed last year. It has become clear that emergency measures, such as those introduced by the European Commission last year, are not enough. The challenge is now for the EU to turn these quick fixes into long-term solutions that will enable a transition to renewable energy and protect consumers from high energy bills.
What to expect?
When Europe started experiencing extremely high energy prices in autumn of 2021, it prompted EU Member States to engage on the best way to intervene in the energy market. Interventions discussed ranged from those less far-reaching, such as imposing a cap on windfall profits of inframarginal electricity producers, to those more radical such as capping the prices of gas or decoupling gas prices from electricity prices. The EU energy regulator, ACER, warned that a reform was not necessary and that the market was functioning quite well under normal circumstances. ACER’s take was that the (troubled) electricity market was responding to unprecedented geopolitical circumstances and that only short-term responses were necessary. The approach from the energy regulator has not convinced Spain and France, which have been calling for a reform since the very beginning of the crisis, and notably to decouple gas prices from electricity prices, to make the cost of electricity independent from the high costs of natural gas.
More than a year after the Russian invasion of Ukraine, the European Commission will put forward its politically-fraught proposal on reforming the bloc’s wholesale electricity market, on 16 March. The Commission has floated different options on the future EU electricity market design, including strengthening the role and uptake of long-term power purchase agreements (PPAs), integrating contracts for differences (CfDs) into the market design, or extending some of the already adopted emergency measures.
What is at stake?
The future of the EU electricity market comes into play at a crucial moment for the EU, just a year before the 2024 European elections, where we could see a shift to the right-wing in Europe. The debates are expected to be lively, with fierce opposition between the pro-interventionist and more liberal Member States. The less interventionist Member States, Germany, the Netherlands, Denmark, Estonia, Finland, Luxembourg, and Latvia, have cautioned against proposing far-reaching changes to the current market design and called for targeted changes to the current system, rather than a complete overhaul of the EU electricity market. EU Member States do not only disagree on the scale of the reform, but also on the timeline. Spain and France are advocating for a swift reform, to be concluded before the end of the year. On the other hand, countries such as Germany would like to wait until after the European elections to reform the EU market, as the EU is still facing geopolitical and energy crises.
The European Parliament, left aside during the negotiations on energy emergency measures, is keen to assert its position, and with disagreements already arising at Member States’ level, it makes it even more unlikely, while not impossible, that the negotiations will be completed before the European elections in mid-2024. It may take a minimum of one year for the co-legislators to agree on the market reform, and up to two years more until it is transposed into national law. Unless EU Member States settle on a two-phase approach to the reform? This possibility was evoked recently by Germany and might be the compromise needed between those advocating for a swift reform, and those wanting to carefully consider long-term changes to the EU electricity market design. Will this evolution of the EU electricity market be the first step toward a future revolution?
How can business respond?
Inflation and multiple interventions in the energy markets over the course of last year have already shaken up investor confidence, bringing into question the future development of renewable and low-carbon technologies. If not designed in the right way, the reform bears the risk of creating fragmentation of the internal energy market and hampering investment incentives. The Commission is expected to present a proposal which will be an evolution rather than a revolution, trying to balance such concerns but this will only be the start of a long period of discussions. The precise timetable for agreeing on the reform will depend on the scope of the proposal and the political will of EU Member States to agree swiftly on the reform, which might not be sufficient.
The EU's upcoming electricity market reform will have significant implications for business, particularly in light of ongoing political instability, rapid shift in the EU energy policy, and changing patterns of international trade and investment. To prepare for potential risks and capitalize on new opportunities, companies should prioritize effective engagement with government, assess dependencies, and develop commercial strategies to hedge against political risk and regulatory challenges. In addition, businesses and investors can play a leadership role in driving sustainability initiatives and promoting viable long-term policies that can in turn strengthen their market position and viability.
Ivana Bartolac is a Consultant in the Flint Brussels office working on sustainability and energy policies and a former political advisor on Green Deal issues for the Party of European Socialists. Corentin Lescroart is a Manager and expert on EU energy and geopolitics at Flint. To find out more about how Flint can help you navigate the risks and opportunities of these developments get in touch.