EU energy ministers agreed on 9 September 2022 on short-term measures to reduce high energy prices, reiterated in the State of the Union address. They called on the Commission to rapidly draw up proposals in the following areas: (1) revenue caps for infra-marginal electricity producers, (2) imposition of price caps for gas, (3) incentives to reduce demand for and (4) liquidity support by ensuring that market participants have sufficient collateral to meet margin calls.
Ceiling on producer income
Economic dispatch-based electricity markets are structured around an order of economic merit – generation should be introduced to the grid starting with the generators offering the lowest prices, followed by progressively more expensive bids, until the request is satisfied. The cost of the last unit of electricity needed to meet demand – the marginal cost unit – sets the market clearing price. In the EU, gas-fired generation can set the marginal price for several reasons, in which case wholesale market prices increase as gas prices are reflected in supply.
The inframarginal price cap being developed at EU level aims to limit the higher revenues attributed to other forms of generation (such as coal, wind, solar, nuclear) accordingly. Preparatory documents described the proposal as “temporarily skimming the revenues of inframarginal producers and using them to relieve the pressure of high energy prices on customers, while leaving wholesale prices unchanged”.
In Ireland, it is important to bear in mind certain nuances regarding the way electricity is traded and subsidized.
The vast majority of renewable electricity generators in Ireland are supported by grant schemes, primarily REFIT (which worked for projects under development between around 2006 and 2015) and now increasingly RESS.
Under the RESS scheme, producers of renewable electricity are required to enter into a power purchase agreement (PPA) with an electricity supply company. The RESS rules require that the price paid to the producer under the PPA be the price it offered at the RESS auction – this is the strike price. Average auction prices in RESS 1 and RESS 2 were lower than today’s wholesale prices. When the market reference price is lower than the strike price (in other words, the supply company could have bought the electricity cheaper on the wholesale markets), the supply company is replenished from the pot OSP down to the strike price level (unless the market reference price is below 0). When the market reference price is above the strike price (as it probably is right now), the supply company redeems the OSP pot.
Notable for Ireland is that the new legislation puts in place a legal basis for supply companies to refund OSP pot money to customers – so there is now a mechanism to channel the difference between the cost of generating renewable electricity and the (higher) wholesale price of electricity to customers.
Previously, under REFIT, renewable electricity generators also entered into a PPA with an electricity supply company (and these contracts are still ongoing). Under the REFIT regime, the supply company under the REFIT PPA is entitled to a supplement to the OSP pot when the market price is below the applicable REFIT reference rate. The PPA price had to be at least equal to the applicable REFIT reference rate (effectively a floor price). It is important to remember, however, that REFIT PPAs – including the price of the PPA – are negotiated privately. It is therefore not known to what extent, in a specific case, electricity generators or suppliers receive the benefit under their REFIT PPA.
Similarly, existing Corporate PPAs in Ireland are primarily structured as Contracts for Difference (CfD), with power generators receiving a strike price by reference to the SEM market price. Questions also arise for the other forms of production intended to be subject to the price cap. They may have various commercial and hedging agreements in place and a one-size-fits-all approach is unlikely to fit all.
Ensuring that market rules support the functioning of an efficient market is an ongoing process. Even before the war in Ukraine, the rules were undergoing significant reform to support a decarbonized energy mix. As it becomes more urgent to protect customers from the impact of war, it is important to recall the key legal principles and intent underlying current market and contract mechanisms, in order to avoid any unintended outcome resulting from well-intentioned interventions.
Encourage demand reduction
Further details are expected on the proposal to coordinate demand reduction across the EU. The 1 September 2022 emergency electricity response non-paper indicates that the main objective is to reduce overall and peak consumption, lower equilibrium prices in electricity markets and preserve security of supply.
The non-paper continues that the “main instruments to be used to achieve this demand reduction could be similar to the demand reduction tenders implemented by some Member States in the gas sector: Member States would request particular categories of consumers (for example, industrial or aggregated). retail consumers) submit offers on the amount of financial compensation they would need to reduce their consumption in pre-established circumstances. …. With regard to final consumers (e.g. households), the reduction in demand could be incentivized by remunerating consumers for the reduction in their consumption…”.
The non-paper suggests that although this has a cost to public budgets, it is not necessarily higher than the cost of supply-side price intervention and would align with the policy objective of the EU to incentivize demand response.
Under EU law, demand-side response is configured as a change in end customers’ electricity load from their normal consumption patterns in response to market signals, including in response to time-varying electricity prices or incentive payments, or acceptance of a customer’s offer to sell the reduction or increase in demand at a price in an organized market as defined in certain provisions of EU law.
This is an entirely different proposition to demand reduction through the use of system tariffs (as proposed in Ireland), as outlined earlier here.