Decarbonization of the electricity sector through increasing renewable energy is transforming electricity markets in Europe. This is creating challenges around intermittent generation, reduced dispatchable capacity, and investment risks. National capacity markets intended to address these risks may distort the internal electricity market. There is currently a lack of political commitment around the EU to long-term solutions, and energy markets are at a crossroads between market principles and regulated investments. The future of EU electricity market design will depend on how policies balance emissions reductions, renewables targets, and ensuring timely efficient investment.

1. MARKET DESIGN AT A CROSSROADS
5 April 2016
Stephen Woodhouse

2. DECARBONISATION IS TRANSFORMING ELECTRICITY MARKETS
Decarbonisation of the electricity sector is central to Europe’s plans to reduce
carbon emissions, and this is set to be achieved through wind and solar
· Intermittent and less predictable generating
patterns
· Reduced access to dispatchable generation
· Utilisation of existing flexibility
➢ Demand side
➢ Cross-border trading
· Investibility of electricity assets
➢ Stabilise electricity pricing (relation to ETS)
➢ Access to hedging markets
· European target model Mark II
➢ Reduced time lag from bidding to execution
➢ Utilisation of transmission grid
➢ Mobilisation of flexibility
➢ Improved investibility
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3. EUROPE IS DEALING WITH INTERLINKED ISSUES, BUT LACK OF POLITICAL
COMMITMENT IMPEDES INVESTMENT
Lack of firm political commitment prevents solutions with investments based on a proper market framework
undistorted by renewables and/or capacity support
2030
Climate &
Energy
Package
Renewables
support
GHG emissions:
– Binding overall target
– Insufficient tightening of the allowance market
Renewable energy:
– Based on support
Energy efficiency:
– 30% reduction in energy use
● General capacity support bites its own tail:
Softens electricity prices and increases
investment risk
● Targeted capacity support is difficult to
design in a reasonable way:
● Restrictions on use of resources?
Capacity
support
● Renewables support distorts ETS and
electricity market balance
● Sub-optimal operation of renewables adds to
the need of flexibility
• Surplus and low prices in both
electricity and allowance markets
• Support distorts the market, whether
it is harmonised or not
• No investments without support
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4. ‘INTERMITTENCY’ WILL BE A MAJOR CHALLENGE
Wind generation is naturally intermittent, with high pressure, low wind areas covering large areas of
Europe at the same time
Weather patterns for 25 December 2006 Generation 22-30 Dec (2030)
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5. CONVENTIONAL CAPACITY FACES NEW RISKS
Increasing levels of intermittent generation across Europe give rise to both price and volume risk for
conventional thermal capacity
Can I invest
based on the
spark spread?
• Scarcity pricing politically
unacceptable (even if it is
economically sound)
• No near-baseload operation
• Volume risks
• Reliance on scarcity pricing
• Market interventions to protect
consumers may seriously distort
the market
Is infrequent scarcity pricing
a credible basis for investment?
Do traded contracts allow both
price and volume risk to be hedged?
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5 APRIL 2016
REGULATORY intervention CREATES ‘MISSING MONEY’
Regulatory intervention and other market-impacting measures (e.g. reserve) impact the price formation
and/or the volumes traded in the different timeframes
‘Missing money’
Other limits
that ‘block’
the arbitrage
between
market
timeframes
and reduce
liquidity
Indirect
impact on
prices from
upfront
reservation
fees
Price caps
and other
bidding
restrictions

7. LARGE EUROPEAN UTILITIES ARE SPLITTING
0
40
20
60
100
80
Indexvalue(rebasedto100)
STOXX Europe Utilities 600
NewCo
Source: Thomson Reuters
The unfavourable market conditions for traditional production capacity has led
some utilities companies to split renewables from other energy production
STOXX Europe Utilities 600 development versus benchmarks
2014
140
Dow Jones Utilities Average
STOXX Europe 600
120
2015
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5 APRIL 2016

8. ARE NATIONAL CAPACITY MARKETS THE ANSWER?
The response is the development of nationally based CRMs which can (further) distort markets and
threaten the coherence of the Internal Market for Electricity
Capacity
auctions
Centralised
ROs
Centralised
ROs
• National CRMs are being introduced, targeting greater
investor certainty and generation adequacy
• However, each CRM developed or proposed in Europe is
different in design, and there are no workable
arrangements yet in place for cross-border participation
• Uncoordinated CRMs risk distorting spot electricity prices,
and may harm demand side response, cross-border trading
and distort investment decisions
Will national CRMs undermine the goal of the Internal Market
for Electricity?
Which of the CRM designs will be accepted by the EC?
What will the EC’s forthcoming market design legislation –
scheduled for end 2016 – bring forward?
Capacity
obligations
“Scarcity
pricing''?
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9. THE LONGER TERM VISION MUST SHAPE THE MARKETS IN THE SHORTER TERM
Evolution of electricity markets
Short
- term
vision
• How to defend
cashflows in the
short-term?
Medium
- term
vision
• Can we invest in
generation capacity
in the face of market
volatility?
Longer
- term
vision
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5 APRIL 2016
• What is the future of
the European
electricity system: a
market or a centrally
planned economy?

10. ENERGY MARKETS AT A CROSSROADS….
Will the future energy
sector be based on
market principles or are
we returning to regulated
investments?
How will EU and national
policy objectives be
balanced in the future
framework? How will
emissions targets and
renewables targets be
balanced?
How will we ensure that
investment is made in a
timely and efficient
manner?
Re-regulation or liberalisation? Rely on European markets and a strong CO2 regime,
or build national solutions with government-channelled investment?
What are the consequences for future electricity market design?
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11. CREATING THE ELECTRICITY TARGET MODEL 2.0
Adapting the European electricity target model to fit a world of flexibility
Target model 1.0
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Full cost imbalance
pricing to cover LRMC
not just SRMC
Co-optimisation of
energy and reserve/
system services
Recognition of
energy options in the
market arrangements
Market based
allocation of network
capacity across
timeframes
Regional coordination
of network planning and
resource adequacy
Coordinated
security standards
Regional allocation of
congestion revenue and
re-dispatch costs
Coordinated and
transparent TSO
protocols in emergency
situations

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STATUS OF CAPACITY MARKETS IN EUROPE
GB
Capacity auctionsSEM
Ongoing price-based
capacity mechanism,
Centralised ROs
being developed
France
CPM rules adopted
Jan 2015; First
delivery expected
2017; currently
investigated by EC
under state aid rules
Portugal
Price-based capacity
mechanism for new
units
Spain
Current price based
capacity mechanism
being re-developed
Italy
Proposals to replace
current mechanism
with centralised ROs
Greece
Transitional price based;
enduring capacity
obligations; Flexibility
market being discussed
(targeted cap payment)
Germany
Discussions about
introduction of national
capacity mechanisms;
Grid stability reserves in
south since 2011
Poland
Proposals for new market
with capacity mechanism
Sweden & Finland
Strategic reserve
supplements energy only
market
Belgium
Market wide CPM auction
being discussed;
Targeted tender cancelled
by EC;
Strategic reserve since
2014
5 APRIL 2016