Concrete suggestions for improvement (part I)

Interview: Alberto Pototschnig – Director of ACER

Concrete suggestions for improvement (part I)

By Jozef Badida

ACER recently published the second annual Market Monitoring Report 2013, prepared in collaboration with the Council of European Energy Regulators. On behalf of EER, Jozef Badida interviews ACER’s Director Alberto Pototschnig about some interesting findings stemming from the Report. Jozef digs for respective explanations and potential solutions concerning the implementation of the Third Energy Package and the completion of the Internal Energy Market.

EER’s Jozef Badida interviewing Alberto Potoschnig (c)Daniela Bartosova

Mr. Pototschnig, the Report reveals three main barriers to entry into retail energy markets across the EU, causing significant social welfare losses to customers - the Report states several billion euros in 2012. First of all, why are switching rates of consumers so low and how could they be improved?

Switching rates are low in many countries, but not in all of them: the European picture is mixed. The reasons for the low switching rates observed in many MSs are fairly complex. In most cases, the main reason is the limited savings which can be obtained from switching. This is due to insufficient retail competition in many national markets. However, even when saving potentials do materialise, consumers may still fail to switch in considerable numbers. Several reasons might drive such behaviour: for instance, a lack of awareness of the possibility of switching or of the saving potentials, or some degree of inertia among consumers, sometime linked to the traditional public ownership of suppliers. Switching rates also depend on the income level: the wealthier a country, the less people will be inclined to switch for the same level of saving. In addition, the degree of maturity of each retail market plays a role. Switching is also limited by the lack of price-driven demand response due to the absence or limited availability of real-time price signals through smart grids and meters. Switching can be stimulated through market reforms (not only at retail level), awareness campaigns promoted by regulators or governments and consumer organisations, clearer government policies in terms of the actual contestability of final prices, and through better information provided by regulators, retailers or independent market players, for instance via web-based price comparison tools and direct regulatory information.

Secondly, 18 out of 27 EU Member States in electricity and 15 out of 25 MSs in gas were in 2012 applying regulated prices to household consumers. What are the reasons for the ongoing regulation of household prices? Isn´t this approach stifling competition in the retail market?

Regulated prices should be a last-resort measure. The reasons usually mentioned are insufficient retail competition and consumer protection. As soon as effective competition is achieved (which may require profound policy and market structure changes in some MSs), end-user price regulation should be removed. If the market is acceptably competitive but regulated prices still persist, they can indeed suppress or distort competition.

Our report provides some concrete suggestions on how to promote retail competition which will eventually allow the removal of regulated prices. For example, the possibility for consumers to switch in and out of regulated prices as often as they wish can promote switching to alternative suppliers, thus facilitating new entry into the retail market and the development of competition.

Thirdly, how do you explain the fact that network charges and taxation often cover more than half of the final price? Do you see any room for improvement there?

Network charges, which cover the costs of transmission/transport and distribution grids, must be effectively regulated in order to provide good value for money, since these activities are not subject to competitive pressure. At the same time, these charges should allow transmission/transport and distribution operators to recover their efficient costs and earn a reasonable rate of return, to ensure their long-term economic and financial viability. National Regulatory Authorities are responsible for the effective regulation of networks. Taxation, on the other hand, is a matter for government policy. The EU’s principle of subsidiarity applies to both general and energy taxation. Having said that, the wide disparities observed in terms of energy taxation are not conducive to a level playing field in the internal energy market.

Loop flows are considered as one of major hurdles of market integration. It is not a secret that the unpredictable generation of wind farms in Northern Germany threaten the security of electricity grids in Central Europe. Planned phase-shifting transformers cannot be a long-term solution. How to tackle the issues of increasing share of RES and loop flows in a cost-efficient way?

Indeed, loop flows pose a threat to the efficient functioning of the IEM and to the secure grid operation. The underlying cause of these flows is the highly meshed network in the Central-South Europe (CSE), Central-West Europe (CWE) and Central-East Europe (CEE) Regions, with electricity flowing not necessarily along contractual paths but rather along the path of least resistance.

However, loop flows are not a new phenomenon and it is a misconception that they are merely caused by the rapid increase of wind farms in Northern Germany - although these wind farms in combination with the sudden shut down of nuclear power plants in (south) Germany and the insufficiently fast development of network reinforcements have significantly increased the amount of loop flows in the CSE, CWE and CEE Regions.

The Agency believes that there is insufficient clarity about the precise levels of loop flows and who is causing them.

The Agency and NRAs, in cooperation with ENTSO-E, are currently working on an appropriate method to identify origins of loop flows and adequate mechanisms to compensate for their negative impact

These aspects need to be further explored in order to assess the costs of remedial actions applied by the TSOs and the loss of social welfare caused by these flows. Once these costs and causes are known in sufficient detail, a financial compensation mechanism can be considered. In our report the Agency has proposed a concrete method to increase the transparency of loop flows. The Agency and NRAs, in cooperation with ENTSO-E, are currently working on an appropriate method to identify origins of loop flows and adequate mechanisms to compensate for their negative impact. As a potential remedy to this problem, the Agency and ENTSO-E are currently performing a review of the bidding zones in Continental Europe.

Have you noticed any significant discrepancies between market coupling in old and new Member States? Could this concept be easily copied to gas markets or is gas target model considerably divergent?

One of our key findings in the Market Monitoring Report indicates that market coupling significantly contributes to EU electricity wholesale market integration. For instance, price convergence in the Central-East Europe (CEE) region has significantly increased. After the implementation of market coupling between the Czech Republic, Hungary and Slovakia, here full price convergence was achieved in more than eighty percent of the time in the last quarter of 2012. There remains however significant scope for further wholesale electricity price convergence across the EU. Jointly with the relevant National Regulatory Authorities and stakeholders we are determined to implement market coupling on the remaining borders.

The market coupling and splitting concept as developed for the electricity sector cannot be implemented as such in the gas sector. However, we are considering whether a different market coupling concept, based on the same principles, can be applied to integrate national gas markets. Recently, a study has been conducted to analyse the feasibility of implicit allocation in North West Europe, the most advanced gas region. The conclusion of the study is that implicit allocation may have added value, but that its feasibility should be better assessed once the new EU rules on capacity allocation and congestion management have been fully implemented.

The European gas target model is not considerably divergent from the electricity target model in this respect,

The gas target model is currently being reviewed to reflect the new demand/supply conditions as well as the changes observed throughout the EU in terms of gas flows, market designs, capacity allocation and congestion management procedures over the last few years

since it does consider the possibility of hub-to-hub trading and trading regions through virtual trading points (which is an embryonic form of market coupling or splitting). However, it is true that - in its current version – the model does not contemplate full market coupling or implicit capacity allocation. The gas target model is currently being reviewed to reflect the new demand/supply conditions as well as the changes observed throughout the EU in terms of gas flows, market designs, capacity allocation and congestion management procedures over the last few years. The Agency is playing a substantial role, together with ENTSOG, the Commission, and industry in driving this new thinking.

Despite the economic downturn and lower demand on the continent, European gas prices are going up. The Report´s arguments are the lack of competition, high Asian prices and oil-indexation of long-term contracts. How could this situation be reversed? Do you believe that spot trading alone is able to guarantee security of supply in Europe?

Gas prices are driven by world demand and supply conditions over which Europe has limited influence. Gas is a primary fuel for which Europe is far from being self-sufficient; the EU is a net gas importer. Spot trading will help gas prices become more transparent and make sure that they remain as competitive as possible. Security of supply can be guaranteed by spot and forward markets, provided the political willingness emerges to make sure that all trades are channelled through liquid gas hubs or exchanges. Trading can be either spot or forward, and long terms contracts can co-exist with exchange-based trading. A fully functional market can - and should - be based on multiple contractual varieties, thereby including bilateral contracts. The crucial issue is not security of supply per se, but the price level at which it can be achieved.

The last part of this interview appeared on Monday 20 January 2014. Pototschnig elaborates on REMIT, more concentrated regulation and ACER’s plans for 2014.