Energy prices have increased significantly since 2021 due to demand transformations in the post-Covid-19 pandemic period and Russia’s war on Ukraine adversely affecting European households and businesses. Specifically, increased energy demand attributed to a dynamic global economy rebound after the pandemic led to increased electricity prices, thereby causing the first wave of an unfolding energy crisis. The second wave triggered by the war on Ukraine and the subsequent Russian weaponization of gas supplies to Europe led to serious disruptions in the flow of gas, further sustaining high electricity prices and severely impacting the European economy. To prevent future price shocks, the European Commission presented a proposal on the reform of the EU Electricity Market Design in March 2023, whose main pillars lie in the optimization of the current electricity market design, the improvement of affordability for consumers, and the decarbonization of the energy system.
A. Reasons for Reforming the EU Electricity Market Design (2023)
The reform of the Electricity Market Design is the European response to an unfolding energy crisis since 2021 that was translated into record-high electricity prices attributed to the recovery of energy demand in the post-pandemic period and the subsequent Russian invasion of Ukraine. The latter has prolonged volatility in energy commodity prices, particularly because of the low level of inventories. The electricity price increases revealed the high level of exposure of businesses and the industry across the EU, as certain energy-intensive firms were either driven into insolvency or limited operations. Concurrently, increased electricity prices burdened economically households at two levels: the first level was the household fuel bills for heating and cooling, and the second level was the final household consumption of energy-intensive, processed goods and services. Increased electricity prices have given rise to the rate of inflation in European economies, subsequently depressing the households’ real income.
An energy prices toolbox was promptly offered by the EU to mitigate the adverse effects of increased electricity prices on households that included income support, concrete tax reductions, and safeguards to prevent disconnections from the grid. Targeted measures were also deployed for the support of businesses in accordance with EU state aid rules, while the REPowerEU plan engulfed additional measures and funding to produce more clean energy and enhance energy efficiency to decrease reliance on Russian energy.
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The energy crisis has brought to the forefront the structural deficiencies pertaining to the electricity market’s short-term focus and subsequent diversion away from longer-term goals. The short-term electricity prices for consumers across the EU mirrored developments in gas and oil prices, leading to price shocks in consumers’ energy bills. Short-term markets, namely the day-ahead and intraday markets, have not functioned properly during this period to the level of better integrating renewables and empowering consumers. In practice, there was no buffer between short-term markets and electricity bills paid by consumers.
Practically, the merit order as a basis for the day-ahead market mechanism largely explains the abnormally high electricity prices, particularly since 2022 when Russian supply to Europe was cut. Specifically, the employment of the merit order approach, upon which the EU electricity market functions, guarantees that the price of electricity increases extraordinarily if gas is the last type of energy used in electricity generation. As a consequence, artificial price increases occur despite the existence of a notable share of renewables in electricity generation. To avert this, it has become evident that the conventional merit order should profoundly give its place to a new merit order where energy storage from renewables replaces the role of conventional peak-load plants.
It has thus become crystal clear that increased gas prices contributed to increased wholesale electricity prices, with carbon prices having had the same effect. More gas-fired electricity was required to meet peak electricity demand. The latter’s price was ultimately affected not only by the gas price but also by the price of carbon dioxide (CO₂), emitted during the gas-fired production of electricity, under the EU Emissions Trading System (ETS). What is also striking to note is that increased gas prices led to the replacement of gas-fired electricity during 2021 by coal-fired electricity, whose emissions intensity and related costs are significantly higher, and despite the profound incentive under the EU ETS to switch to the production of cleaner sources of electricity, this did not happen. As a consequence, the cited situation has undermined the prime goal of the European Green Deal for a transition to a net zero economy.
What also has become crystal clear during the energy crisis is that the aging electricity grid and its overdue modernization have been an additional factor that is driving electricity bills higher, necessitating the modernization of the infrastructure networks that must be interconnected and stable to enable the green transition. Adding to the above, inflexible grid infrastructure and uncoordinated regulatory interventions combined with price volatility have necessitated the reform of the EU Electricity Market Design.
B. Objectives of the EU Electricity Market Design
The reform of the electricity market design centers on long-term viable solutions to strengthen the EU’s resilience to future price shocks, improve its protection against market manipulation in the wholesale electricity market, and better integrate renewables. The reform aims to complement the short-term markets with a considerable role for long-term contracts, facilitating investments in clean technologies and consumer benefits from more fixed-price contracts. To this end, the reform to improve the EU electricity market design amends the Electricity Regulations of 2019, the Electricity Directives of 2018 and 2019, and the Regulation for Market Integrity and Transparency (REMIT).
The new EU Electricity Market Design rules that incentivize the clean energy transition while delivering on the key objectives of energy security and affordability entered into force on 16 July 2024 with Directive 2024/1711 and Regulation 2024/1747. The reform of the EU electricity market design foresees provisions that center on two pillars, namely, consumer protection and empowerment and enhancement of energy costs’ predictability and stability to boost industrial competitiveness.
(I) Consumer Protection and Empowerment
The EU Electricity Market Design’s new rules introduce measures to protect consumers from price volatility, necessitating the need for a transparent model that showcases the true costs of energy and offers incentives for individuals to become active in generating their own electricity. The main philosophy of the reform is that it allows consumers and suppliers to benefit from more price stability based on renewable and non-fossil energy technologies.
Specifically, the reform provides a variety of options and clearer information to consumers before signing an electricity contract to best fit their circumstances. This way, consumers have the flexibility to choose either dynamic pricing contracts to make the most out of the price variability and use electricity when it is cheaper or fixed-term contracts that allow them to lock in secure, long-term prices to moderate the impact of abrupt price hikes.
The reform also encourages energy sharing that empowers vulnerable customers and customers affected by energy poverty, leading to enhanced absorption of renewable energy through the mobilization of additional private capital investment. Electricity sharing is expected to enhance the flexibility of smaller consumers who will be in position to invest in solar parks and sell rooftop solar electricity to neighbors, except for their supplier. Synoptically, small-scale generation installations by consumers will not only reduce their electricity bills but will also allow them to share energy with targeted consumers, thereby fostering a more interconnected and sustainable energy community.
On top of the consumer protection, the reform ensures that vulnerable consumers and the energy poor will be protected from disconnection through the employment by EU member states of available tools and good practices such as year-round or seasonal disconnection prohibitions and sustainable solutions to support customers who face hardship in paying their energy bills. The reform also foresees the establishment by EU member states of a supplier-of-last-resort regime whose main function lies in the designation of a supplier of last resort, preferably before supplier failure.
As highlighted in the EU Directive 2024/1711, which lays down the rules for the improvement of the EU electricity market design, the sales division of a vertically integrated undertaking, which also performs distribution functions, on the condition that it meets the unbundling requirements of Directive (EU) 2019/944, can be appointed as a supplier of last resort. In addition to the cited protection framework for the vulnerable and energy-poor customers, the reform allows member states to temporarily extend regulated prices below costs to households and small and medium-sized enterprises when, in times of crisis, wholesale and retail electricity prices increase considerably. This mechanism is allowed on the condition that the regulated prices do not distort suppliers that must be compensated for the costs of supplying at below cost.
The reform also clarifies that consumers must be gradually equipped with smart meters, encouraging member states where their rollout is still slow to improve conditions for their installation. The reform underscores that data from dedicated measurement devices must be made available, upon the consent of the final consumer, to the transmission and distribution system operators and relevant market participants, including independent aggregators.
For consumers to fully benefit from integrated electricity markets, the reform pays attention to the improvement of the functioning of the European electricity forward markets in terms of the frequency of allocation and the maturity, along with ways to strengthen the secondary market that is a loosely structured market and involves a number of private agreements, options, swaps, over-the-counter derivatives, and other financial instruments.
Overall, the reform of the EU Electricity Market Design addresses consumers’ concerns over exposure to volatile short-term prices that are driven by high fossil fuel prices through the provision of a concrete protection framework allowing them to benefit, among others, from fixed-price contracts and renewable energy sharing.
(ΙΙ) Enhancement of Energy Costs’ Predictability and Stability to Boost Industrial Competitiveness
The reform provisions foreseemeasures to incentivize longer-term contracts with renewable power production and bring more clean flexible solutions into the system to compete with gas, such as storage. For the improvement of investment conditions, especially for green energy businesses committed to reducing their carbon footprint on the way to climate neutrality by 2050, the reform of the EU Electricity Market Design pays special attention to ways for countering exposure to short-term price increases by prioritizing longer-term contracts for business developers.
For the development of offshore renewable and low-carbon energy projects, the reform of the electricity market design identifies instruments such as power purchase agreements (PPAs) or the direct price support scheme of the two-way contracts for difference so that stable revenues are safeguarded along with risk and capital costs’ reduction. Specifically, the new reform rules clarify that Member States should grant support schemes by means of two-way contracts for difference to either repower or prolong life and expand capacity in existing power-generating facilities.
Two-way contracts for difference are deemed to be a useful tool that guarantees that producers’ revenues, arising from new public-supported investments in electricity generation, are less dependent on the unstable prices of fossil-fuel-based generation. The introduction of two-way contracts for difference between public entities and electricity generators enhances flexibility in the energy market and curbs high market prices, as this type of contract sets a minimum and a maximum price, so any revenues above the ceiling are paid back. The reform rules stress that these revenues should be funneled by member states to small and medium-sized enterprises and energy-intensive undertakings, thereby sustaining their business operations and guarding them against electricity price fluctuations.
The reform also underscores the importance of further developing forward electricity markets to allow consumers and suppliers, including owners of power-generating facilities using renewable energy sources, to hedge against the risk of future volatility in electricity prices. Suppliers stand in need of efficient forward markets to decrease dependence on short-term prices and cover long-term price exposures.
Long-term instruments, such as two-way contracts for difference, combined with improved liquidity in forward markets are key for capital-intensive investments in renewable technologies, given the price stability and long-term visibility on returns they provide. In essence, the reform rules envision shifting energy from the highly volatile spot markets, where prices are determined by the costs of the most expensive technologies that enter the matching, towards medium- and long-term markets with greater price stability.
The reform of the electricity market design aims to enhance the competitiveness of the EU industries by facilitating investments in clean technology that will help meet the EU’s net zero targets. A robust clean technology manufacturing basis can shore up the energy transition. The Electricity Market Design’s reform provisions favor the affordable electrification of the European industry and envision solidifying the EU’s position as a global player in the research, development, and innovation of clean energy technologies.
In total, the reform of the electricity market design aims at enhancing the stability and predictability of energy costs for businesses, thus ensuring affordable electricity for the European industry’s competitiveness through the introduction of longer-term agreements such as two-way contracts for difference.
(III) The Role of Power Purchasing Agreements (PPAs)
The reform of the electricity market design promotes the employment of power purchase agreements (PPAs) as long-term tools that guarantee price stability to both consumers and suppliers, enabling the latter to proceed with an investment decision. Under a power purchase agreement, a power generator agrees to sell energy directly to energy consumers at a predetermined rate, either fixed or escalator, for a set duration that typically ranges from 15 to 20 years. This arrangement enhances the energy costs’ predictability, thus enhancing the competitiveness of European industry. Renewable energy suppliers are provided with reliable revenues, thereby lowering their financial risk and significantly reducing their cost of capital, acting as an accelerator for investments.
Despite the profound benefits, most power purchase agreements are signed by large energy consumers in a small number of Member States. The reason that impedes the adoption of PPAs lies in market barriers, with most prevailing being the credit risk associated with a consumer’s inability to purchase electricity over the entire contract duration.
To reduce the financial risks associated with off-taker payment default, the reform of the Electricity Market Design recommends that Member States employ certain instruments, such as state-backed guarantee schemes at market prices, private guarantees, and facilities pooling demand for PPAs, in line with the applicable EU law. In search of boosting demand for PPAs, the reform recommends that customers that face entry barriers must be incentivized to enter the PPA market, while renewable energy project developers should be allowed to reserve a share of the generation for sale through a PPA when participating in a public support tender.
Additional restrictions of legal nature to the conclusion of PPAs, stemming from the national legislation of Member States, center on third-party ownership of on-site renewable installations, the number of buyers per installation, the transfer of guarantees of origin to the off-taker, and cross-border PPAs.
Applauding Directive (EU) 2018/2001, whose provisions aimed, though insufficiently, at overcoming such legal barriers pertaining to PPAs, the reform reiterates that Member States should evaluate any given regulatory and administrative barriers to long-term renewables PPAs and remove discriminatory procedures or charges so that such agreements are integrated into their national energy and climate plans. It is also noteworthy that the reform explicitly prohibits Member States from supporting PPAs for the purchase of electricity generated from fossil fuels.
Multi-year power PPAs present an invaluable tool that can finance new investments in low-carbon generation involving different types of customer counterparts, thus accelerating the power generators’ commitment to sustainability and achievement of decarbonization goals on the way to energy transition. Customer counterparts can include large energy consumers that opt for corporate PPAs, governments that finance low-carbon generation projects, and retailers that purchase PPAs for their fixed customer base. In the face of challenges that volatile energy markets create, PPAs offer a clear pathway that can stabilize energy costs, align power generators’ financial performance with environmental goals, enhance the generators’ exploration for new technologies and operational models, and serve as a catalyst for innovation.
Conclusion
The reform of the EU Electricity Market Design is expected to play a crucial part in phasing out Europe’s dependence on fossil fuels for electricity generation, thereby shifting away from energy models dependent on Russian imports.
In full line with the European Green Deal and REPowerEU goals, the reform prioritizes the enhancement of Europe’s energy security and industrial competitiveness through the integration of renewables across the power system and a greater role for longer-term instruments such as power purchase agreements and two-way contracts for difference.
Above all, consumers’ protection and empowerment remain at the core of the EU Electricity Market Design, proving that its reform is human-centric, prioritizing consumers’ needs and active engagement in the electricity markets along with other market players so that an inclusive and sustainable energy future is forged.
