The current price difference between renewable energies and fossil fuels is stark and weighs heavily on electricity prices across Europe. A quick solution to this would be to keep the current marginal pricing system for fossil fuels and create a separate market for renewables where prices would be defined at the time of auction, writes Mike Parr.

Mike Parr is director of PWR, a UK-based company providing market research and technical support in the field of renewables and energy efficiency. 

In comments before the European Parliament last week, the President of the European Commission, Ursula von der Leyen, correctly identified the need for substantial reform of electricity markets.

This is something that people within the Commission and myself have been arguing for, during at least the past 2 years. The president’s cabinet and those of Commission Timmermans are familiar with our arguments, which we have made on several occasions (here, here and here).

Electricity market reform needs to broaden to cover European energy markets. Either by chance or design the section of the speech on electricity market reform was followed by a brief summary of actions on natural gas storage.

Our reform proposals foresee a converged electricity and gas (natural gas and latterly hydrogen) system, where gas (hydrogen) storage plays an important role.

In her statement, Ms von der Leyen noted that electricity markets reform would be a “huge reform” and that it “will take time”. Huge reforms usually do take time and for reasons I will outline shortly we do not have the time needed to develop, for example, a “4th Energy Package”. A different approach to reform is needed.

The speech contained hints of what that reform could be. It correctly identified that the current market design is more than 20 years old and is based on a completely different set of circumstances (relatively low cost fossil fuels and relatively high cost renewables).

The current price differences between new renewable and fossil fuels are stark and play out in national markets on a daily basis. Wholesale price oscillations can be by two orders of magnitude in 8 hours, a clear indication of a malfunctioning market. Do tomatoes in the local super market daily oscillate in price between €0.5/kilo and €50/kilo?

As a first step, we propose a market split. The dynamics of fossil-fuel-based generation are wholly different from those of renewables, where the price for renewables is usually fixed at auction and connected to a contract for difference (CfD).

Fossil fuelled generation would sit, as now, in a market based on marginal pricing. Renewables would sit in a separate “market” where prices would be fixed using the price defined at the time of auction. A composite price for all renewables (each with its own fixed price) could easily be arrived at. The only variable being the amount of renewables generated. Price setting becomes less a regulatory issue and more a data comms and computing project.

The final wholesale price would be set by a mix of marginal and composite prices and respective volumes. The legislative effort to do this would be trivial, and would reduce wholesale electricity prices by 50% or more, according to our estimates. Implementation of such a system could be in months, if the political will was there.

The need for fast action on electricity market reform is driven by member state’s renewable ambitions. Taking the example of Germany, the installed base of renewables is now circa 120GW. Commendably, the plan is to expand this to 360GW by 2030, 8 years hence. Very low or negative wholesale electricity prices due to renewables are now a regular feature of the German market, as well as others. 360GW of renewables within 8 years will have an even greater impact on wholesale markets. Spain and other countries have similar renewable ambitions in similar time frames.

Under current Contracts for Difference (CfDs), renewable owners are compensated, even if electricity prices are extremely low. This means that under current markets structures, consumers will pay twice for the same electron – once for the energy, a second time to cover CfD costs. Furthermore, changing CfDs will not solve the problem, CfDs are a key element in providing the future revenue certainty that renewable developers need to build the renewables that the EU needs.

Splitting the electricity market into two parts eliminates this negative result (pay twice for the same electricity), dilutes the impact of high-cost fossil-based electricity and delivers the benefits of low cost zero-carbon electricity to citizens. It does not need a 4th Energy Package to do this, it needs as noted, data communications and computers. Furthermore, splitting the market, has little to no impact on cross-border trading, given that a final wholesale price is still arrived at, thus providing the price signal needed for cross border trading.

Moving to the bigger picture, large amounts of renewables in any member state will need large-scale storage. Demand response and batteries have a role to play in smoothing the output of renewables in times frames of less than 24h hours. However, the only system that will scale to the Terawatt hours of storage needed before 2030 is a re-purposed gas system/gas storage system. Furthermore, if we are going to de-carbonise the totality of the electrical power system, this means that we will need to use green-hydrogen in generation and we will need large amounts of storage, both for the power sector and industry (which has its own hydrogen trajectory). How will this be managed is an open issue, but one that needs to be resolved within 8 years or less.

The changes that the European energy system will undergo in the next 10 years requires a flexible regulatory response. A series of short steps are needed, rather than the quantum leaps that characterised the various energy packages. Time is against the old approaches and learning by doing, albeit “small doings” might be the best way forward.

On 13 June, the UK government announced that it would propose legislation later in 2022 to reform its electricity market by splitting the market into two parts, one with gas generation and the other with renewables. This is being done to reduce electricity prices.

This begs the question if, as seems likely, this is an act of political desperation by an embattled Tory government, why can’t the EU act in a similar time frame?