Electricity market design: Fit for Net Zero - Policy recommendations

The transition towards a net-zero economy by 2050 requires stepping up the volume of investment across the energy sector and end use sectors, while ensuring better engagement and protection opportunities for consumers. This study aims to address these challenges and contribute to the ongoing debate about electricity market design to make it fit for the energy transition.

The energy crisis triggered by the conflict in Ukraine has demonstrated the resilience and benefits of an integrated European market. Yet, the crisis has also highlighted some of the gaps in the current market design and the need to pass on the benefits of renewables’ and other low-carbon technologies’ stable generation costs more directly to consumers.

In this report, we present an analysis of the key gaps in the current market design with recommendations to complete the set of existing markets to support an efficient transition toward net zero over the next decades. The market design reform will need to preserve the cost-efficiency and national and cross-border competition delivered by the internal EU energy market by building on the current market framework.

Policy recommendations put forward in this report focus (i) on the proper implementation of existing EU legislations and regulations, (ii) on the removal of barriers and obstacles and (iii) on market-based solutions to reinforce incentives for stakeholders to contribute to the challenges faced by the power system and to achieve the transition towards a net-zero economy. These recommendations were carefully defined to foster consumer engagement, maintain the efficiency of price signals, and improve transparency, liquidity and competition for all timeframes. On the contrary, measures that would be detrimental to these objectives would be counterproductive and should be avoided.

To reach these recommendations, the study started in June 2022 and has followed a structured and interactive approach to analyse the key gaps in the current market design, and to identify potential solutions. The study is built upon many interactions with Eurelectric’s members as well as external stakeholders.

These policy recommendations are structured in three main pillars: (i) a consumer contracting and engagement framework based on enhanced forward hedging opportunities and retail price structures, (ii) an investment framework underpinned by enhanced long-term hedging/contracting opportunities, and (iii) a framework to coordinate the future system needs to meet security of supply and policy objectives.  

An enhanced customer contracting framework – enabling sufficient possibilities for generators, customers, and suppliers to hedge and contract, including over the long-term – would bring the benefits of renewable energy sources (RES) and low-carbon generation more directly to consumers, while still providing efficient short-term signals fostering active demand participation in short-term markets. This enhanced hedging framework will be required to:

1. Guarantee adequate information for consumers and sensibilisation to risks so they may commit for longer periods;
2. Ensure suppliers’ resilience to avoid rapid, unexpected market exits and consumers losing their suppliers unexpectedly;
3. Enhance hedging opportunities to protect consumers against medium-/long-term price volatility (beyond one year); and
4. Empower consumers further and facilitate demand-side response.

A market-based investment framework is necessary to step up deployment of both renewables and low-carbon technologies, as well as firm and flexible resources (including demand-side response and storage), and the supporting network infrastructure. The framework for RES and low-carbon investment should allow investors to choose or combine whether to enter public de-risking contracts, to enter private power purchase agreements (PPAs) or other forms of private contracts, or to participate in the electricity market directly. The investment framework should provide revenue stabilisation opportunities though long-term contracts to foster investment and reduce financing costs while preserving effective incentives to participate in the forward, spot, and balancing markets. Different types of measures identified to enhance long-term contracting include:

1. A role for capacity mechanisms as a core part of the market design to ensure adequacy and security of supply, and facilitating their implementation for Member States that would opt for such mechanism;
2. A private framework for RES and low carbon contracting, usually referred to as PPAs, which would aim at removing barriers to PPAs and improving transparency and standardisation, and potentially reduce counterparty risks and actively drive demand if Members States elect to provide active support;
3. A public framework for RES and low-carbon investment with the evolution of RES support schemes toward de-risking schemes that should be designed to bring the benefits of long-term contracting to consumers and to minimise distortions in the market; and
4. Facilitating hedging through the improvement of forward markets by e.g., removing barriers to hedging on forward markets.

Last, an enhanced framework to coordinate the identification of the future system needs is required for the timely development of sources of flexible and firm power, as well as key networks and infrastructures alongside the growth of clean technologies. New opportunities will emerge, both on the supply side with new storage technologies, and on the demand side with new flexible loads from the electrification of the transport, industry, and buildings sectors. An enhanced framework for assessing, in a forward-looking and in a holistic way, the evolution of system needs is therefore necessary to provide visibility for market participants and network operators, by:

1. Expanding the scope of system needs assessment to have a ‘whole system’ perspective, to include wider system needs (network, firm capacity, flexibility), cross-sector assessments and for a longer timeframe, such as 2040 and 2050;
2. Improving the current methodologies used in system needs assessment, to better adapt to a changing energy system; and
3. Reviewing the governance arrangements to conduct the system needs assessment, accounting for cross-sector, distribution level, stakeholder inputs.