EU avoids 'breaking the glass' with electricity market reform plans

A long-awaited proposal from the European Commission to redesign the EU's electricity market avoids the kind of fundamental overhaul that some had touted during the height of Europe's energy crisis in 2022.

Instead, the reform focuses on encouraging long-term contracts, such as power purchase agreements and contracts for difference, to avoid future price spikes and decouple consumer prices from short-term volatility.

EU Energy Commissioner Kadri Simson said the crisis, fueled by Russia's invasion of Ukraine, has "exposed a number of shortcomings" in the EU's market design. A focus on short-term trading has "amplified the effects of the gas price rise," Simson said in a March 14 news conference.

Still, the EC stopped short of a wholesale redesign, meaning the so-called merit order, where the cheapest generation technology is used first, remains untouched.

"We're in a much better place now," Kristian Ruby, secretary-general of utility trade group Eurelectric, said about the EC's proposals, pointing to previous comments from lawmakers that suggested a more wide-ranging overhaul.

"This reform is a glass that's not broken, and there was a risk of really breaking the glass," Ruby said in an interview. Now, "it's probably half full rather than half empty."

Calling for more long-term contracts

Under the EC's reform, price formation in the short-term markets will not change, but generator revenues will be increasingly shaped by long-term contracts.

Part of its plan involves opening up the market for power purchase agreements to a wider pool of buyers — for instance, by using guarantees to help reduce credit risk barriers.

Member states will also be obliged to use two-way contracts for difference, or CFDs, for new investments in low-carbon generation. Under a two-way CFD, a model used already in places like the U.K. for renewables, generators receive a fixed price for their electricity and have to pay back the difference if market prices are higher.

Analysts at Morgan Stanley said the drive for long-term clean energy contracts would benefit renewables developers like Ørsted A/S, EDP Renováveis SA, Corporación Acciona Energías Renovables SA, Enel SpA, RWE AG and Iberdrola SA.

"Offering customers stability through long-term clean energy contracts has been core to our strategy for years, so we welcome measures that seek to strengthen these aspects based on market mechanisms," Ignacio Galán, executive chairman of Spanish power giant Iberdrola, said in an email.

The proposal is also good news for nuclear operators like CEZ a.s. and Engie SA, according to Morgan Stanley, given it would allow two-way CFDs to be used when extending the life of low-carbon assets, including nuclear plants.

Retroactivity avoided

Low-carbon generators will ultimately retain the flexibility of selling their power under long-term contracts or going fully merchant. Part of the EC's proposal is the creation of virtual regional hubs for forward power contracts to consolidate liquidity.

"It's all about a balance between forward markets, public support in different forms, then allowing space for market participants to strike deals with each other," Ruby said. "This could have gone terribly wrong [but] it's looking fairly alright."

A spokesperson for Sweden's Vattenfall AB added that it is important financial support programs for clean energy generation remain voluntary, while Italy's Enel said PPA trading platforms, which are not mentioned in the EC's proposal, would be a "valuable instrument to ensure the aggregation of demand and ultimately improve the long-term liquidity of the market."

Naomi Chevillard, head of regulatory affairs at lobby group SolarPower Europe, described it as a "relief" to see that CFDs would only be required for new projects, alluding to previous calls that said the contracts should also be used for operating assets.

"We're particularly grateful to have avoided CFD as the only route to market for new solar, or retroactive CFDs on existing solar projects," Chevillard said in a statement. "Investors can trust that the terms of their investments won't suddenly change."

Reform will provide 'better' market

Among the EC's other measures, consumers must be able to access long-term, fixed-price tariffs for their general supply, while at the same time accessing dynamic pricing tariffs for electric vehicles or heat pumps. Member states should also set targets for non-fossil flexibility, potentially supporting demand response and storage while enabling system operators to buy demand reductions at peak hours.

The final result is what Coralie Laurencin, senior director and power and climate policy lead at S&P Global Commodity Insights, described as a "light-touch proposal aimed at providing a 'better' market instead of a full market transformation."

"[The] large set of measures to protect consumers both in usual times and in energy crisis times recognize that there is only so much prosumers can do without some supportive framework," Laurencin said.

Simson described the electricity market reform as an "essential and hopefully [the] last" element of the EU's response to the energy crisis. The proposal needs approval from the European Parliament and European Council before entering into force.

Researchers at Brussels-based think tank Bruegel said political discussions might become "long and complex," given the EC does not provide a consistent picture on how old and new market instruments might interact with each other.

"About €80 billion in investment in the European power system per year is needed and the stakes are just too high to risk getting the incentives wrong," the researchers said.

S&P Global Commodity Insights reporter Henry Edwardes-Evans, who contributed to this story, produces content for distribution on Platts Dimensions Pro. S&P Global Commodity Insights is owned by S&P Global Inc.

S&P Global Commodity Insights produces content for distribution on S&P Capital IQ Pro.