Opinion & Analysis

European Electricity Market Reform – Ambitions and Realities

The EU’s electricity market reforms do a good job of promoting more stable energy prices. But member-states must do more to deliver a fully integrated EU-wide energy market.

The events of the last two years in Europe – spiralling gas prices, the war in Ukraine and some of the tangible impacts of climate change – gave us a dramatic illustration of the dilemmas facing energy policy-makers. They have the unenviable task of trying to meet three important objectives of the ‘energy trilemma’ at the same time:

  • guaranteeing security of supply so that lights can stay on, we keep warm in winter and not too hot in summer, and the economy can work and we can keep our jobs and prosperity
  • making sure that we produce and use energy sustainably, including to fight climate change;
  • ensuring that we have access to energy which is affordable for households and cost-competitive for business.

Public opinion and politics tend at any particular time to emphasise one or two of these objectives but rarely try to pursue policies which try to encompass all three together. In responding to the recent price spike, EU law-makers risked taking short-term decisions to reduce prices, that would have bad long-term consequences for sustainability and security. Instead, they took a sensible and measured approach. But the best way to deliver all three objectives simultaneously is to focus on reforms to improve energy infrastructure and deepen European energy integration.

In the 1980s and 90s, policy-makers in Europe, starting in the UK, focused on injecting some degree of competition into electricity and gas markets in order to improve security of supply and make energy more affordable. These sectors had previously been dominated by national public monopolies which were not very efficient and gave consumers (households and businesses) no choice of supplier, raising concerns about consumers being potentially ripped off. It was not easy to change this. Electricity and gas are network-based industries, parts of which are natural monopolies – like the gas distribution pipes and the electricity grid. Policy-makers had to regulate these networks, since they would face very little competition. They also had to separate the management of networks from more competitive parts of the market, like energy generation and retail supply. Otherwise, the monopolies would have incentives to distort competition among generators and retailers. Consequently, every country in Europe now has a national energy regulator and an independent electricity grid operator.

But most countries also realised that, even in supposedly competitive parts of the market, competition would not work immediately: many consumers would not have the time or confidence to shop around for the best energy deal. You could not deregulate energy markets without ensuring adequate protection for consumers, especially the vulnerable. So national energy regulators were given the remit not just to promote competition between retailers but also to ensure that retailers treated consumers fairly.

Yet, in the early 2000s, the political focus changed to another of the three energy policy objectives: sustainability. It was not good enough to have competitive supplies of energy. The generation and supply of energy based on fossil fuels was polluting the atmosphere with large amounts of carbon dioxide. Therefore, future energy supplies needed to be carbon-free. The technologies which could enable this were either expensive and/or controversial (nuclear) or at that point relatively untried and costly (renewables). Therefore, energy policies started to concentrate on investing in these technologies and where possible bringing their costs down.

But by the early 2020s, the policy emphasis changed again as it was not clear how to guarantee sustainable supplies of energy at affordable prices. Russia’s invasion of the Ukraine exposed the vulnerability of Europe to a cut-off in pipeline supplies of Russian gas. As gas was in short supply, its price rocketed. Furthermore, in Europe’s wholesale electricity markets, purchasers of energy pay all energy producers the same ‘clearing price’ – the price at which enough energy is produced to meet demand. The objective of having one ‘clearing price’ is to promote efficiency: energy which is cheaper to produce earns greater profits. However, the clearing price is often set by gas plants, since they can be turned on and off to meet changing demand more easily than renewables. Effectively, this means gas normally sets the price of electricity, so when gas prices rise, electricity prices increase too.

The reaction across Europe at the political level to rising gas and electricity prices was mixed. Most governments took measures to protect ordinary households and economic sectors which relied heavily on gas or electricity. Some installed price caps at the wholesale or retail level. Others said that the market was working well and that high prices gave the correct incentives to consumers to reduce their consumption and to the market to change sources of supply in the short and medium term, and these governments therefore provided support in other ways, such as through one-off payments. EU member-states eventually agreed to a cap on the wholesale price of gas but at a level – €180/MWh – which is unlikely to be reached given current developments in the global gas market. The market price has been below €100/MWh throughout 2023 and is currently less than €30/MWh.

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About the author

Sir Philip Lowe KCMG is a distinguished fellow at the Centre for European Reform and a partner in Oxera Consulting. He graduated from St John’s College, Oxford and London Business School. Following a period in industry, he joined the European Commission in 1973 where he was Director-General for Development (1997-2000), for Competition (2002-2010) and for Energy (2010-2014). He was a non-executive director of the UK CMA (2013-2016) and is currently Chair of the EUI Competition Law Workshop, and of the World Energy Council’s Trilemma Initiative.

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