On 14 March 2023, the European Commission (EC) proposed1 to reform the EU's electricity market design following the recent energy crisis. The proposal includes revisions of Regulation (EU) 2019/943, Directive (EU) 2019/944, Directive (EU) 2018/2001 (RED 2) and Regulation (EU) 2019/942 (ACER Regulation).
The full text of the proposals is available at: Electricity Market Reform for consumers and annex (europa.eu).
What’s not in the proposal?
Firstly, some of the rather revolutionary changes proposed by different market actors and a few Member States, during the preparation have not made the final proposal.
The EC’s proposal does not fundamentally modify the price forming on the day-ahead wholesale market. Therefore, very high gas prices will still be able to trigger very high electricity prices on the day-ahead electricity market.
The proposal does not extend, nor solidify, the revenue cap and taxation above the cap (Windfall Profits Tax) for electricity generation (applicable until 30 June 2023). There is no general principle of claw back introduced to recuperate windfall profits.
Finally, the proposal does not require that all existing public support for renewable projects to be modified to a two-way contract for difference mechanism.
What’s in the proposal?
1. The EC’s proposal does not modify pricing on the day-ahead wholesale market
In the day-ahead electricity wholesale market, power plants with lower marginal costs are dispatched first. However, the price received by all market participants is set by the last power plant needed to cover the demand, which is the plant with the highest marginal costs when the markets clear. Gas (or coal) fired power plants often have the highest marginal costs needed to meet the demand for electricity. The exceptionally high price of natural gas therefore tends to trigger exceptionally high prices on the day-ahead electricity market.
Some EU Member States advocated for a fundamental reform aimed at directly reducing the impact of high natural gas prices on wholesale electricity prices. Other Member States and market players cautioned against such a reform. Ultimately, the EC’s proposal does not modify the day-ahead wholesale market pricing mechanism; it does however include several measures to mitigate the impact.
2. The EC proposes a shift towards long term Power Purchase Agreements (PPAs) and more stable long-term pricing
The EC intends to stimulate long term Power Purchase Agreements (PPAs) between producers and off-takers, which should lead to more stable (and less volatile) prices. The credit risk for the off-taker under the PPA can be reduced by State guarantees (which qualify as State aid under certain circumstances). Tenders for public support should reserve a quantity for PPAs and specifically those with different types of off-takers. The EC envisages the creation of reference hubs for forward contracts to increase price transparency. PPAs could refer to such a price reference, which is probably more stable, than the potentially volatile day-ahead market price reference.
3. The EC favors public support for investments in the form of a two-way contract for difference
The EC incentivizes public support for investment in renewable or low carbon (e.g. nuclear) electricity generation in the form of a two-way contract for difference, containing both a minimum and maximum price. In the case of low market prices, the public support would top up the price until the minimum price is reached. In the case of high market prices, the price above the maximum would be paid back by the producers and ultimately channeled back to the consumers.
Note that when applying EU State aid rules for new renewable projects, a two-way contract for difference is already a form of support favored by the EC. The novelty in the EC’s proposal is paving the way for public support for investments in low carbon electricity generation, including repowering or lifetime extensions.
4. Retail price regulation during times of crises
The EC accepts the necessity of regulated retail prices for SMEs and consumers in the event of a crisis. This is on the condition that the amount of electricity at a reduced price is set below the average consumption, in order to maintain an incentive for demand reduction.
The EC will monitor market prices and declare a regional, or EU-wide, emergency in case of sustained excessive prices for a period of up to one year, during which price regulation tools can be applied.
This will also have an impact on retail electricity contracts, by introducing the right for consumers to a (yearly) fixed price contract, or alternatively for dynamic pricing when the consumer wishes to take advantage of price variability with one or several suppliers.
5. Fostering demand side flexibility, storage and peak shaving and promoting energy sharing
The EC intends to foster demand side flexibility, storage and peak shaving solutions. They also intend to broaden the scope of energy sharing amongst auto-producers and off-takers to allow for both sharing or selling of electricity without the need to create “energy communities”. Note that this somewhat reduces the utilization of the concept “energy communities” that was recently introduced.
As part of the next steps, the proposal will have to pass through the legislative process (voting and possibly amendments) at the EU Parliament and the Council of the EU. The Spanish presidency of the Council aims for a wrap up of the new rules by the end of December 2023. The European Commission, on the other hand, is striving for the rules to be ready before the next winter period.
Modifications to the different EU regulations are applicable as soon as the amending regulations enter into force. The modifications to the different EU directives, will have to be transposed in national energy laws.
We will continue to keep up to date with the proposal as it evolves. Should you have any questions, please reach out to one of our experts.
Author: Thomas Verstraeten