Why the EU needs more integrated electricity markets
bruegel.org
bruegel.org
If you speak French, this series of video on the Heu?reka YouTube channel explains all this very well, both from the technical side and from the financial side. The videos are rather long because they go in depth on the subject:
- Comprendre le marché de l'électricité (Understanding the eletricity market) : https://www.youtube.com/watch?v=ienoSbONyhw
- Les super-profits des fournisseurs alternatifs (The super-profits of alternative suppliers) : https://www.youtube.com/watch?v=P3to46JLDu8
- Comprendre la bourse de l'électricité : le maché SPOT (Understanding the electricity exchange: the SPOT market) : https://www.youtube.com/watch?v=rZCKv0C6Dqs
- Pourquoi prix de l'élecricité = coût de la centrale la plus chère ? Comprendre le modèle (Why the price of electricity = the cost of the most expensive central? Understanding the underlying model) : https://www.youtube.com/watch?v=Ep3biZAtitE
This, it's basicaly the "financialization of electricity".
When I looked at the cost of electricity production vs the buying price for it in my country there was a total disconnect.
The power plants don't feed my country anymore: they feed the market, which then scams the buyers.
Natural monopolies should be in the hands of the people through the State, allowing grifters to append themselves to extract rent from those natural monopolies is just ridiculous...
That is because, for certain modes of production (renewables, nuclear), most of the cost is paid up-front during construction, and the cost of production is minimal. The plants (nuclear, solar, wind) are effectively financial devices, where someone takes a huge loan or otherwise gets capital at yearly interest, and slowly pays it off.
If you check Bruegel membership, you'll see mostly financial institutions and consultancies. So it's not even alternative suppliers who benefit.
The reason the system is so f*d up is because we are gambling with a system critical resource. Not every system benefits from competitive markets especially infrastructure. Having a good working electricity network benefits the greater good and enables business to operate. This does not translate to short term market profits where you need to squeeze every possible dime out of the system. From cutting unneeded maintenance to paying the lowest possible salaries will catch up with you in 10-20 years when the system collapses. The tax payer will be the one paying for the damages and the "criminals" that caused the damage will be retired with their fortune.
I don't think you're taking a clear view of the incentive structure around expensive capital assets. These are massive investments in infrastructure that often need to be paid back over 10-20 year periods before they make a profit. At some point the investment becomes so huge that the owners are incentivised to run even at a loss for a year or so to avoid the pain of writing down the capital they spent so much on.
Skimping on maintenance and salaries isn't what the incentives push towards in a free market. In fact, having worked in similar environments, there is a slight tendency to overpay on salaries and over-invest in maintenance since they make relatively little difference to the profitability of the project and the derisking is extremely valuable.
If an investor isn't planning on paying for maintenance and playing a long game, infrastructure investment is unlikely to appeal (at least not in a standard free market).
That is more of a technical issue though, when I say they'll run at a loss, I mean purely because when you do the profit-maximisation numbers strange things happen when the capital investment is very high.
Even if each country's energy system was operated by a state owned enterprise, the overall system would be cheaper and more reliable if countries could better send energy across borders.
North Sea wind could be exported southwards during periods of weak solar and vice versa. France could import fossil fuel energy during periods of nuclear downtime.
Don't worry they also thought about this, the EU wanted price caps on nuclear because EDF was supposed to make way too much money from the gas crisis & general winter consumption.
The electricity "market" in the EU means supporting the Energiewende, no matter how bad it's failing.
On the one hand: Europe is a block, and Europe is better for it, given the realities of geopolitics. A common energy infrastructure and policy are integral to making such a block function. Power, electrical or political, needs to be organized for it to work optimally. The European democracies can then define what optimal means: what do we actually want to optimize?
That's the other hand: I agree that a commercial marketplace is not the right focus, at least not now. Europe needs energy sovereignty more than a place for capitalists to extract value. We need to guarantee there is value to extract for future generations first, as the Russian invasion in neighboring Ukraine shows. We can bicker on who makes how much profit later.
Making Europeans less sensitive to macro events in their energy bill is one aim, giving European industry, a foundation under the EU as a power block, is a second aim. We can only make meaningful progress with a well integrated energy market and integrated policies on these subjects. I read the article in this spirit, not in the spirit that Europe needs more deregulation and more commercial opportunities in this market.
Transmission-loss reduction is a good example of how Europe might deepen cooperation: HVDC lines are rapidly becoming feasible and economically interesting. By their nature, the require cooperation of multiple jurisdictions and thus policy frameworks, potentially hundreds if including sometimes powerful local governments.
I will also note that although they have succeeded in removing the UK from their maps, they cannot suppress the Swiss spirit. Well done Switzerland for being irrepressible.
Right now they are pushing to build more gas pipelines to replace Russia so I'd say no to that.
The lessons from the russian war have not been understood and this was such a big event that I don't know what else would help.
Also Germany is building LNG terminals, but they take time and LNG is more expensive than normal natural gas, so the only "benefit" is political because they can say "we're not buying from Russia", but nothing else.
So it's a bad thing diplomatically, environmentally and economically.
Spent few weeks trying to help someone find out what kind of setup they need with the switchover, because even the grid compliance officer didn't know...
The Ukraine conflict forced the transition to renewables to be accelerated and plans for a transition from coal to gas to be shelved; probably permanently.
Germany no longer is dependent on Russian gas at this point and it never was very dependent on nuclear even before it put in motion the plan to get rid of it completely almost 15 years ago. People are whining about this a lot but it doesn't really matter.
The energy gap is much bigger than the retired nuclear could ever fill and it was never going to be a big part of any short term solution to addressing that gap. It sure would have helped, a little bit. But in the end Germany managed fine without it.
The simple reality is that unless you already have a nuclear plant up and running, getting a new one is going to take probably well over a decade even under the best of circumstances. Probably more like two decades in Germany. Germany only had a few nuclear plants left in 2021 and they are now gone. New ones were not being planned. So like it or not, nuclear simply was not going to be a major factor in the German energy crisis. The 8GW of nuclear that was left and is now gone was never going to be anywhere close to enough.
Renewables are a different matter. The amount of generation added on a yearly basis is way more than the nuclear capacity they got rid off. The crisis has caused investments to be stepped up and the timeline to be accelerated. So much so, that despite the above, coal usage is not really growing. It just temporarily stopped shrinking. And we're already on the tail end of that too and the shrinkage will resume. At this point, the main challenge is actually not generation but energy transport and storage. It's doubtful coal will be completely shutdown by the mid 2030's as per the original pre-war plan. But it's going to decline in importance between now and then.
LNG as a fuel for gas plants is stupidly expensive and unlikely to be something that will be stepped up. It's a stop gap solution to keep existing plants going and that will increasingly be in the role of peaker plants that are only operational when they have nothing else. But I expect they'll be needed less and less.
Investments in the energy generation and transport infrastructure is going to have to step up of course. This will be good for Germany and Europe. More cables means more resilience against local weather and climate related peaks and dips in wind and solar generation and less dependence on foreign fossil fuel imports.
This isn't exactly an outlier we're dealing with here, we're seeing a situation that was always somewhere between plausible and probable depending on how much trust the assessor had in Russia before 2022. I'm going out on a limb here and saying that the current situation - purposefully avoiding producing energy, followed by an energy crisis - cannot be classed as good for Germany or the EU.
From the lowest point every direction of travel goes up, I suppose. In that sense hopefully the decisions made today are of higher quality and sure, it is in some way good that they've been delivered a clear warning shot and will now hopefully react to it by adjusting their policies.
Oh, but it does matter. With high gas prices at the start of the war and shutting down the nuclear - this made electricity price go up all around Germany. Because Germany was in need for electricity and was buying it abroad. So this decision in Germany made poorer people in other countries pay more.
Any price increases in surrounding countries should be blamed on the policies of those countries first, and of course the Russians. And let's face it, a lot of countries were overly dependent on Russian gas. Trusting the Russians was a big mistake. And lots of countries fell for that.
In an interconnected market, when energy gets scarce, prices go up for everyone. And Germany can afford to pay high prices and it did. A lot of countries selling energy benefited from that. Oil and gas companies did really well and made record profits. And lots of countries declined to tax that appropriately and chose to let these companies keep their profits instead of taxing it and using the revenues to help those people. Don't blame the Germans, blame your local government for that. And then blame yourself if you voted them into office. Choices have consequences. And if you didn't, blame your fellow citizens.
In my country we don't have energy generation from gas. At all. Why should I blame my government?
My friend, you came up with a lot of excuses for Germany. The one I can agree with is the war that Russia started. You country was the most dependent on russian gas. You pushed for new gas pipelines with Russia even at the last moments before the war.
I think in France right now we could reinstate the guillotine just for him.
The entire point of infrastructure is that the government runs it at a loss, the loss gets captured by the private sector/household, and the multiplier effect makes it a positive thing on the whole. The government should ensure the money is well spent, but if it is then 1 dollar of electricity deficit(on government side) is like 1.2-1.3 dollars of surplus somewhere else on the balance sheet.
It's the real disease of the EU. There's no problem of failed policy that shouldn't be addressed by deepening the policy and making it harder to back track. The only possible response to problems of complexity is to make the complexity more intractable.
The way I see 2022 was a crisis of energy PRICES, had the markets not been there it might have been a crisis of energy AVAILABILITY. Strictly worse.
If you will, this is like saying you need an exchange for trade. Well, no, OTC markets exist.
The markets made sure that the plants got their costs covered and stayed online.
One can argue whether the last-price-wins is the best market structure but how would you have forced plants to generate at a loss without nationalizing them?
I don't really understand your point here. In an otc trade, costs are also covered, no one works for free.
That being said, my original point was not even about that. It was more about lines in the article that strongly hint that, in the author's opinion, the current issue is politicians not doing enough to force their citizen to swallow the pill. Relevant paragraph:
> Further market integration requires substantial political investment. Governments will need to deal with significant distributional effects within and between countries. Experience has shown that domestic political constraints in this respect are often numerous and difficult to overcome.
I'm simply saying that markets have no first-order effect on availability.
As for prices, it's another matter.
The electricity market price is downstream dependent on gas market price among others. You want to also remove gas markets then?
Anyway, I would gladly hear what would have 2022 looked like had there not been electricity markets.
Production can't be ramped up significantly in the span of a crisis. In that sense, a different trading scheme wouldn't have made a difference in terms of resource availability during the crisis.
> The electricity market price is downstream dependent on gas market price among others. You want to also remove gas markets then?
Not sure what connection you make between that and my point.
> Anyway, I would gladly hear what would have 2022 looked like had there not been electricity markets.
From an availability PoV, exactly the same. Markets are not responsible for making sure that production is available, or actually used ; that's the role of TSOs.
What do those words even mean?
If you are a power plant and your consumables price goes up. If you can't get the price you sell electricity at increased then you will shut down and your generation will be not available to the grid.
That simply doesn't happen. Whether an exchange is there to "facilitate" trade, or whether Alice in Paris calls bob in Frankfurt to ask how much 2 GWh will cost for the next day, money will change hands, and the plant will work.
All the while thinking if only there would be an online service to sort out the best deal .... oh wait
Why would this option be ignored?
We need some production sites to be operated at a loss, because they have to be maintained the whole year while they may be of use only a few weeks or days per year — but those times we cannot do without them.
No market will ever be able to make that happen, those have ti be publicly owned. Why, oh why on earth would be decide that the benefits should be privatized while the losses have to stay public? Especially when the result of privatization and market policy is that electricity is more expensive for everyone in the end.
Full nationalization would remove incentives for build out of new generation and renewables.
> Especially when the result of privatization and market policy is that electricity is more expensive for everyone in the end.
Do you have any references to point to that would claim that a nationalized power system would be cheaper than market? Seems like a very bold claim.
As for the references, I linked to them (it's in French however) in another comment here.
Also, all of the progress and innovations and building of new generations and renewables and everything until recently has been done without a market, at least in France, which probably has one of the best electricity system in the world.
Because nothing nationalized works.
As such I don't see an issue with an integrated electricity marked, if you at the same time ensure that countries and companies doesn't simply stop investing in energy infrastructure because: We can just buy what we need from someone else.
It's fine to buy cheap wind power and shutdown a power plant if the wind is blowing, but if you only building wind farm and assuming that you can piggy back on the nuclear reactor or dams next door when the wind stops blowing, then it quickly falls appart. Each country, or region, needs to have a plan for self-sufficiency, in all circumstances, but that's not a financially sound idea. Better to have a electricity shortage once in a while, if you only care about money. This is the bit that the EU does not understand. For some reason the EU has always had a blind spot when it comes to the actions companies, and countries, will take in the name of financial gains.
This is the way 100% of power grids work, even the more autonomous ones. The cost to remove some once-in-a-century risks is simply too high.
So every single grid operator focuses on two parameters: how often does an equipment fail, and how impactful it is to lose it.
It is fundamentally broken:
- It has been designed around the marginal cost of production. Which implies that the price of Electricity is directly correlated on the price of Coal and Gas. A top level ludicrous move in middle of a green energy transition.
- It is designed around the concept of energy (Twh) without any consideration on the notion of the power at peak. Consequently their is almost no financial incentive from investors to pay for storage capacity or production medium that will be needed during peak hours. It is a system that makes the grid more and more unstable with time and the states have to compensate that with massive subsidies for storage and fossil fuel power plants...
- The general idea to propagate the variability of the energy price on the final customer by making small business pay themselves at market rate has shown to be a gigantic mistake. A Lot of small business were not able to afford "temporarily" 3-4-10x the average electricity price due to sudden envy of Vladimir Putin to visit his neighbour. The variability killed them, that was entirely avoidable.
This article has been written by the financial people. The same gurus that put this idiotic system in pplace.
Wierdly, every middle size company owner I know has a very different point of view about this when they receive their energy bill.
I don't follow your logic.
If there is a large difference between prices during the day then there is a large incentive to build daily storage. You earn more the bigger the price differences there are and the more storage comes online the more prices even out over the day.
Real peak does not happen during the day.
The real peak happens around 10-15 days per year, during winter and when temperature drop. These are the days where protecting the Grid against blackout is challenging.
No investor are keen to billions on the table for an hypothetical investment that will be profitable 10 days per year, at best.
Are you saying that 10 or 15 days of blackout per year at the level of the European is an acceptable situation to have ?
If so there is a lot of problem in your perception of what is a power grid.
Please read my section about peak power again. Their no mention of prices :)
The main concern about peak power is related to the grid stability (risk of blackout) and not correlated to price.
Euphemistically acknowledged in the paper: "Governments will need to deal with significant distributional effects within and between countries."
The crisis was self-inflicted by the EU on itself: Brussels dropped imports from Russia and the prices went high-sky. They could have minded their own business and Europe could have enjoyed low gas and energy prices, but no... why waste an opportunity of a war to screw something up?
You can downvote me as much as you want, but every government's job is to ensure the best for its people and then and only then help others. And because gas prices have tripled/quadrupled for political reasons only, I consider this a failure of all EU governments towards their citizens.
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A government that ceases to exist (eg. by being conquered) fails to do anything at all, let alone what is best for its citizens.
This is almost a tautology, because eg. try to make a "list of governments that do not exist".
(see also: https://en.wikipedia.org/wiki/Night-watchman_state for a view on the absolute minimal requirements for a workable state.)
By buying energy from adversaries you fund their activities against your own government. This compromises the primary duty by weakening your government in the long term.
Russia had been a "bad neighbour" for over two decades now. In terms of energy policy, worse than Soviet Union (there's reasonable argument that they traded on relatively stellar reputation soviets made when it came to energy supply to the West).
Cheap energy is not everything, and I do not mean here some nebulous (to some) concepts of decency and honour. I mean physical and political safety of the citizens. Several EU countries border Russia. All of them have history when it comes to Russian nationalism (which coincidentally is pretty big in Russian government). And Russians aren't quiet with their saber rattling. Appeasement only results in confirming that threats work to get you to comply, after all.
If anything, the current increase in combat was a wakeup call that "Wandel durch Handel" was a total failure with regards to Russia. For decades, belief in "Change through Trade" constrained possible actions to ensure safety and wellbeing of EU citizens, against belligerent who was all too happy to manipulate energy access to cause issues. Not to mention significant portion of the fossil fuels from Russia... flowed through Ukraine.
So if anything, diversification from Russian gas was at most ripping the bandaid out, something that should have been initiated at latest in 2014 (when it was proposed by Poland), but it was not the first attempt to do so. Pity it took 8 year war kicking into higher gear for some to finally understand.
Or, as I think it would have been even better, have citizens vote independently with their wallets. I for example, don't buy Turkish products because I think Erdogan is a-hole and a dictator. But I don't have a problem with other people buying Turkish products. So you could pass a law where citizens would have the option do deny consuming Russian gas and opt for Caspian Sea natural gas, or LNG from Qatar or whatever and pay the appropriate price. Providers would sell them gas from their preferred source and everyone would be happy.
Otherwise we could just do away with the whole overhead of democracy.
And happily would manipulate supply and prices to apply pressure on the government policy.
So you have to ask yourself, is temporarily cheap gas worth losing the ability to decide for yourself? To provide the best for your citizens?
Russia reduced supply already in 2021 and then in 2022, too, until it ceased supply via Yamal to Poland and Germany as well as via NS1 (prior to its destruction).
Also, Austria is still using Russian gas, for example, and there are no sanctions on Russian gas other than on LNG.
What, a large scale war of aggression, by far the worst that happened on this continent since 1945, that flooded the EU with a million of refugees, is somehow not our business?
And should we trust Putin the Faithless when he declares that he is not interested in the Baltic states, which belong to the EU? He allegedly wasn't interested in Ukraine before.