Format: Policy Brief
Date: 13 March 2023

How Europe can make its power market more resilient

Recommendations for a short-term reform

#European Green Deal

Preface
Key findings

Preface

The full-scale invasion of Ukraine in February 2022 intensified the fossil energy supply crisis that was already being experienced in Europe and beyond. Supply shortages and spiking fossil gas prices drove up the wholesale market prices for electricity, because electricity generated with natural gas often sets the market clearing price. The energy price crisis has brought about a broad political commitment to strengthen the resilience of the EU’s power system, in order to improve the management of future shocks and prevent negative impacts to households and firms. In this policy brief we propose several elements that a short-term reform should focus on.

We show that investment in renewable energy can provide a structural solution to the fossil fuel supply crisis while putting Europe on track to achieve climate neutrality. We also illustrate the key importance of an integrated European wholesale power market with marginal pricing to ensure the efficient use of electricity while also maximizing power system flexibility and security of supply. In addition, we explain how Europe’s power market can become more resilient to fossil fuel price shocks through voluntary two-sided contracts for difference, PPAs, and a coordinated policy for skimming-off windfall profits, thus shielding consumers from electricity price spikes. Finally, we set out further elements of short-term market design reform and provide an outlook concerning a more far-reaching reform of the market’s design.

Key findings

Short-term, well-targeted measures to protect consumers from power price shocks must be consistent with Europe’s transition to a power system based on high shares of renewables.

Such a fully decarbonised system will be much more decentralised while relying on renewables, flexibility and an active demand-side. The EU Commission should initiate a well-prepared debate on necessary further adjustments to EU power market rules during the legislative period that starts in 2024.
Ramping up renewables and energy efficiency will provide a structural solution to the supply crisis while keeping Europe on track to achieving climate neutrality. A well-functioning internal electricity market is crucial for the efficient operation of an increasingly renewables-based power system.

Renewables investment should be ramped up to close the supply gap and reduce Europe’s dependence on fossil fuel imports. Annual onshore wind deployment needs to triple while annual offshore wind and solar PV deployment needs to quadruple by 2030. Marginal pricing on wholesale markets will ensure the efficient use of electricity, balance supply through cross-border trade and enable demand-side flexibility and storage.
Voluntary two-sided contracts for difference (CfDs) should become the standard approach for governments to support renewables investment, alongside merchant approaches such as power purchase agreements (PPAs).

CfDs can ensure predictable revenue streams from renewable energy projects, thus reducing risks for investors and lowering financing costs. CfDs can also facilitate the market integration of renewables and skimming-off of windfall profits, generating revenues that can be used for targeted support. To quickly scale up renewables deployment, investors should be able to decide whether to use government-backed CfDs or to develop merchant-based renewables projects, e.g. through PPAs.
The combination of two-sided CfDs, PPAs, and the skimming-off of windfall profits in emergency situations will help protect consumers from spiking power prices in the event of future fossil-fuel supply shocks.

A harmonised EU approach to reducing windfall profits during emergency situations should replace the current inframarginal revenue cap, as the uneven and unpredictable implementation of the revenue cap is scaring off renewables investors. In the medium term, with a growing volume of renewable electricity produced under CfDs and PPAs, windfall profit claw-backs will become less relevant.

Bibliographical data

Authors: Christian Redl, Matthias Buck, Frauke Thies, Fabian Hein, Alexander Dusolt
Publication number: 288/02-P-2023/EN
Version number: 1.0
Publication date: 13 March 2023
Pages: 18
Suggested Citation: Agora Energiewende (2023): How Europe can make its power market more resilient. Recommendations for a short-term reform.
Project: This publication was produced within the framework of the project Electricity market design for the energy transition.