Bourses dnergie

Electricity market integration in Europe

Leonardo Meeus, Ronnie Belmans, University of Leuven (KUL), Leuven, Belgium

Keywords: energy markets and regulations

Abstract

Europe is preparing for a third wave of legislation to further reform electricity markets. The energy sector
inquiry conducted in preparation of this third energy package concluded that there is lack of market integra-
tion. Even though this is true, it is important to put this in perspective. For the moment, electricity markets in
Europe are indeed not the most harmonized or fine-tuned of the world. However, in some regions promising ini-
tiatives have already been launched and even when only integrated regionally, these markets will be the largest
in the world, which indicates how ambitious the target of a single electricity market for Europe really is.

Rsum

LEurope se prpare une troisime vague de lgislation pour poursuivre la rforme des marches de llectricit.
Lenqute prparatoire auprs du secteur nergtique a conclu un manque dintgration du march. Bien que
cela soit exact, il est important de mettre ces conclusions en perspectives. Pour linstant, les marchs de llectricit
ne sont, bien sr, pas les mieux harmoniss du monde, ni les mieux ajusts. Cependant, dans certaines rgions,
des initiatives prometteuses ont t lances, et mme si lintgration nest que rgionale, ces marchs seront les
plus grands au monde. Ceci indique lambition du but dun march lectrique unique en Europe.

Samenvatting

Europa bereidt zich voor op een derde wetgevingsgolf die de hervorming van de elektriciteitsmarkten moet
voortzetten. De voorbereidende studie van de energiesector leidde tot het besluit dat de markten onvoldoende
gentegreerd zijn. Dit klopt weliswaar, maar het gegeven moet wel in perspectief worden geplaatst. Op dit ogen-
blik zijn de elektriciteitsmark-ten in Europa inderdaad geen toonbeeld van harmonisatie en zijn er in de wereld
markten te vinden die beter op elkaar zijn afgestemd. In bepaalde regios werden evenwel veelbelovende initia-
tieven genomen en ook al beogen deze slechts een regionale integratie, toch zullen hieruit de grootste markten
ter wereld ontstaan. Dit toont hoe ambitieus de doelstelling van een eengemaakte elektriciteitsmarkt voor
Europa eigenlijk is.

Introduction
January 2007, the European
Commission published the third energy
package, i.e. a set of roadmaps, progress
reports and the final results of the
energy sector inquiry. The package also
proposed future objectives, targets and
actions. September 2007, the
Commission consequently proposed its
new legislative package, which still
needs to be approved by the representa-
tives of the Member States in the
European Parliament and Council
before it can be endorsed [1].
The most critical and controversial
report of the third energy package has
been the energy sector inquiry. The
main objective of such an inquiry is to
gather information to identify possible
distortions in competition. The energy
sector inquiry was launched in 2005,
which required companies, trade asso-
ciations and government agencies to
supply information or state-ments. The
final report of the energy sector inquiry
[2] concludes that the lack of electricity
market integration mainly results
from insufficient interconnecting infra-
structure between national electricity
systems, insufficient incentives to
im-prove cross border infrastructure,
inefficient allocation of existing capa-
cities, and incompatible market design
between TSOs and/or spot market
operators.
The contribution of this paper is not to
question these conclusions. On the con-
trary, many issues indeed still need to
be tackled in order to create a level
playing field in Europe [3]. The inten-
tion of this paper is rather to put the
conclusions of the energy sector inquiry
in perspective. When discussing elec-
tricity market integration in Europe, it
is important to consider where we come
from, where we are and where we are
going with the creation of a single mar-
ket for electricity in Europe.
Where do we come from?
While the first reforms were mainly
motivated by the European internal
market policy, the reforms that followed
were trig-gered by the in 2000
approved Lisbon Agenda, in which

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energy was considered one of the criti-
cal fields to improve competitiveness of
European undertakings. Meanwhile,
energy and a common energy policy for
Europe are even higher on the agenda.
The first legislative package that
started the reforms only included the
Directive 96/92, the second included the
Directive 2003/54 and Regulation
1228/2003 and the third proposes
amendments to the existing Directive
2003/54 and Regulation 1228/2003 and
an extra Regulation to establish an
agency for the cooperation of energy
regulators in Europe. While the first
Directive allowed virtually everything,
except a single electricity market in
Europe, the second gave less freedom to
the Member States and had shorter-
term deadlines. Furthermore,
Regulation 1228/2003 for the first time
explic-itly addressed cross-border
issues. Note that in contrast with a
Directive, a Regulation does not need to
be transposed into national law, which
allows less room to maneuver for
Member States.
Note that a uniform harmonization of
all relevant national legislation across
the European Community rarely
occurs. Direc-tives therefore typically
only provide a framework that leaves
some room to maneuver for Member
States, but the Directive 96/92 clearly
left too much room to maneuver. As dis-
cussed in [4], the first draft of this
directive was published in 1991, but on
successive occasions the Commission
was asked to devise a less radical
approach to the market reforms.
As commented in [5], the EU market
reform process has been very different
from elsewhere in the world as it
included retail competition from the
start. Directive 96/92 introduced the
concept of eligible customers who have
the legal capacity to contract volumes
of electric energy from any supplier.
This Directive however included a slow
and gradual market opening, which has
been accelerated by Directive 2003/54:
all customers became eligible from 1st
July 2007, while for all non-households
customers this was already the case
from 1st July 2004.
To benefit from this freedom to choose a
supplier, retail customers or their sup-
pliers need an appropriate wholesale
market organization, non-discriminating
network access and transparent pricing
6 Revue E tijdschrift 124ste jaargang/124me anne n 1-2008 (maart/mars 2008)
Fig. 1: Day-ahead price differences in Europe for base load (Energy Sector
Inquiry [2])
institutions. The EC Directive 96/92
hardly addressed these issues and the
EC Directive 2003/54 only partly with
somewhat stricter unbundling require-
ments between network and other
activities and the requirement to
appoint a regulator who has to approve
tariffs, monitor congestion manage-
ment methodologies and act as a
dispute settlement authority.
Due to a lack of a European-wide
energy regulatory authority, market
integration in Europe has been mainly
driven by informal regulatory networks
between network operators, standardi-
zation authorities and national regula-
tors. The establishment of the Florence
forum, which is academically supported
by the Florence School of Regulation,
has allowed these informal regulatory
networks to meet and discuss twice a
year since 1998. For a more detailed
discussion of the Florence process and
its relative success, see [6] and [7].
Finally, an EU-wide academic network
has formed, for example via the SESSA
(currently renewed in CESSA) program
and with the establishment of a
European Energy Institute.
Where are we?
Do we have a single electricity market
in Europe? Note that the Commission
itself has so far nearly always defined
the rele-vant market as being national
in scope in merger and acquisition
rulings, arguing that the developments,
leading to wider than national electri-
city markets, are uncertain and not
fulfilled in the short term [9].
When will we have a single electricity
market in Europe? Often quoted neces-
sary conditions are a level playing field
and adequately available network
capacity. It is however not clear to what
extent this for instance implies a stan-
dardized market design and/or a single
price for Europe. In the following two
paragraphs we discuss the overall elec-
tricity market integration status and
some regional successes that are
promising for the future.
Overall status
There are still large wholesale price dif-
ferences between countries in Europe.
Fig. 1 illustrates for 2005 that for
instance the prices in Italy, Ireland and
the UK are almost double the prices in
Norway, Sweden, Finland, Poland,
Slovakia, Austria and Slovenia. Note
that these are even average day-ahead
prices for a base load contract, which
averages out the even larger hourly
price differences.
Interconnection capacity is scarce
across Europe and little progress has
been made (see for instance [8] for a
more detailed discussion). The
European Council in Barcelona in 2002
set as a target for 2005 that all Member
States should have an import capacity

of at least 10 % of installed generation
capacity, which is for instance still not
the case for Italy, UK, Ireland, Spain
and Portugal.
As discussed in the introduction, there
is also still a lot of room for improve-
ment in terms of creating a level
playing field, but there has also been a
promising evolution. Largely thanks to
Regulation 1228, transit transmission
charges on cross border exchanges and
non-market conform allocation of cross
border transfer capacities have been
abolished. Physical cross-border
exchanges in Europe have increased
from 7.6 % of electricity consumption in
1998 to 10.3 % in 2005 [10].
Regional successes
Fig. 2 illustrates the 3 regional markets
which are leading the way to future
electricity market integration in
Europe.
The oldest and most well-known
regional market is the Nordic market
(Nord Pool). Norway is not part of the
European Union, but started reforming
already before the European Union and
is following the European electricity
market reform process. Nord Pool started
as the Norwegian power exchange in
1995 and its day-ahead wholesale auc-
tion trading system has extended to
Sweden in 1996, Finland in 1998,
Denmark in 2000 and partly also into
Germany in 2005. The day-ahead auc-
tion system uses the internal border
capacities to optimize the clearing of
orders introduced in the different coun-
tries. Every country corresponds to one
or more price zones. The Nordic coun-
tries have for instance also started har-
monizing their intra-day and real time
market systems.
Much more recently conceived and
relatively fast to launch is the Central
Western European market for the
moment including France, Belgium and
the Netherlands, launched in 2006
(TLC). When a cooperation agreement
was first signed in 2003, both France
(Powernext, started in 2001) and the
Netherlands (APX, started in 1999) had
already well-established power
exchanges and Belgium was in the
process of launching its own exchange.
They have chosen to coordinate their
existing trading systems, instead of
choosing one single system for their
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Fig. 2: Existing regional markets in Europe
day-ahead operations. Apart from this,
they also use the internal border capa-
cities to optimize clearing of orders
introduced to their day-ahead auctions,
like in the Nordic market. In contrast
to the Nordic market however, they are
for the moment only allowed to use a
small fraction of the available border
capacities.
The long awaited Iberian market
(MIBEL) was finally launched in 2007.
In contrast to the Central Western
European market, the existing
exchanges in Spain and Portugal have
divided responsibilities. The Spanish
exchange OMEL takes care of the day-
ahead auction market for both coun-
tries and the Portuguese exchange
OMIP organizes the futures market. As
in the Nordic market, all border capa-
city between Portugal and Spain is
available to the day-ahead market.
Where are we going?
In relation to where we are going with
the market reforms in Europe the fol-
lowing two paragraphs discuss two
interesting developments. The first is
more related to the path we will follow
towards a single market and the second
to the moving target of what is
Europe.
Regional strategy
In 2004, the Commission communicated
for the first time that regional mar-
kets may be a necessary interim stage
in its medium term strategy paper [11].
With this communication, the
Commission basically transferred what
was happening anyway in some regions
into a strategy for all regions. Fig. 3
illustrates the regional strategy as
originally communicated by the
Commission. Note that it includes 8
regions that do not overlap. Note also
that the in 2004 already existing
Nordic and the announced Iberian mar-
ket are indeed included as a region.
The Commission also started to actively
promote regional markets with the
organization of Florence mini-forum
meetings between December 2004 and
February 2005, addressing congestion
management on a regional basis. In
2006, the European Regulators Group
for Electricity and Gas (ERGEG) in
cooperation with the Commission then
renewed the regional strategy by set-
ting up the seven regional initiatives
indicated in Fig. 4 [12]. In every region
there are now regular meetings on
issues as day-ahead, intra-day and real
time market operation, but for instance
also coordinated transmission expan-
sion planning, etc. Note however that in
contrast with the original regional
strategy, the regions are different and
7
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Fig. 3: Regional strategy as originally communicated in 2004 by the European
Commission (DGTREN, [11])
Fig. 4: Regional strategy as renewed in 2006 by the regulators group (ERGEG,
[12])
overlapping. In practice countries
involved in more than one region can of
course not be equally committed to
every region at the same time.
Also in the US, regional markets are
increasingly becoming a reality with
some of them even covering part of
Canada, as illustrated in Figure 5.
Similar to the Nordic market, these
regional markets are the result of one
system that has been ex-tended to an
increasing number of states. The best
example is PJM that started ten years
ago as the market operator of Pennsyl-
vania, New Jersey and Maryland and
has gradually extended to 13 states and
the District of Columbia that includes
the capital Washington. The Federal
Energy Regulatory Commission
(FERC) also tried to transfer what was
happening any-way in some regions
into a strategy for all regions. Fig. 6
8 Revue E tijdschrift 124ste jaargang/124me anne n 1-2008 (maart/mars 2008)
illustrates the regions that the FERC
suggested, but which have not been
supported by the federal authorities. In
the US, there is no commitment to work
towards a single market, not even to
introduce market reforms in every state.
Many states in fact have not even started
reforming their electricity markets, as
indicated by the blanks in Fig. 5.
The author in [7] uses the metaphor of
agglomerative magnets to point out
that the existing regions in the US will
tend to expand further, but for newly
joining entities the rules of the game
are predefined by the existing model.
Also the most developed regional mar-
kets in Europe may function as agglome-
rative magnets for other countries in
the future. The Nordic market has
indeed already been extended on several
occasions and there is for instance also
already a political agreement for
Germany and Luxemburg to join the
Central Western European market. The
difference with the US is that the
existing re-gions in Europe have not yet
harmonized their rules to the same
extent. As discussed in [13], EU market
design in general is less fine-tuned as
for instance the PJM design. For newly
joining entities the rules of the game in
the European regional markets are
therefore less predefined, which should
make it easier for them to expand.
There is however always the risk that
several strong regions develop which
then become more difficult to integrate.
A first sign is perhaps the delay of the
coordination of the day-ahead market
operations of APX with Nord Pool. This
has been planned since the approval of
the cable project interconnecting
Norway with the Netherlands in 2004
(NorNed), but meanwhile the
Netherlands is part of the Central
Western European regional market
with France and Belgium which has
recently officially prioritized the exten-
sion to Germany and Luxemburg [14].
Energy community
The single electricity market undertaking
is becoming increasingly ambitious in
terms of size. First, at the start of the
electricity market reforms in 1996, the
European Union included 15 countries.
Anno 2007, it already includes 27 coun-
tries. Second, since 2005 the Energy
Community is larger than the
European Union. In 2005 the European
Union signed the Energy Community
Treaty with several countries from
South-East Europe that are not (yet)
part of the EU. In the framework of
their general collaboration with the EU
(and perhaps future membership), they
agreed to implement the same electri-
city (and gas) market reforms as the
Member States of the EU. It is also the
intention of the Commission to extend
this policy to other countries like for
instance Turkey who was involved but
did not yet step in with the first group
of countries. Note that for instance also
Norway and Switzerland have been
observing members in this process.
For the moment the largest market in
the world is PJM (Fig. 5). A single elec-
tricity market in Europe would of
course be much larger (Fig. 7). Note
that if Germany joins the Central
Western European market initiative,
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this regional market would even
already be larger than PJM, although
still less fine tuned and harmonized in
terms of design. As indicated in Fig. 5,
PJM has a 145 GW peak load and 728
TWh annual consumption. Belgium,
France, Germany and the Neterlands
have a 191 GW peak load (13 + 81 + 80
+ 17 GW) and 1246 TWh annual
consumption (90+478+559+116 TWh).

Conclusion

Market reforms in Europe have until Fig. 5: Regional realities in North America, with illustration based on [15]
recently been mostly national and
divers as the European legal framework
allowed Member States to maneuver
even more than what is normally the
case with European Directives.
Meanwhile the framework is becoming
more stringent and the European
Union is increasingly committed
towards creating a single electricity
market as part of a common European
energy policy.

Even though it is not fully clear what a

single market means in terms of for
instance wholesale price equality Fig. 6: Regional markets in US as envisaged by the FERC
across Europe or interconnection capa-
city, it will require further harmoniza-
tion and coordination of market rules
and operations. In some regions there
are already some positive develop-
ments, especially in the Nordic, Central
Western European and Iberian mar-
ket. Faced with what was happening
anyway in some regions, the
Commission has even started promote
a regional strategy for all regions as an
interim stage towards a single electri-
city market in Europe.

For the moment electricity markets in

Europe are therefore not the most har-
monized or fine-tuned of the world, but
they will soon become the largest. If the
Central Western European market
which already includes France,
Belgium and the Nether-lands is
extended as planned to Germany and
Luxemburg as foreseen in the so-called
pentalateral agreement, it will soon be
the largest market in the world, larger
than PJM in the US.
To sum up, when discussing the rela-
tive success of market reforms in
Europe today, it is very important to
consider how it has started and how
ambitious the target of a single electric-
ity market in Europe actually is.
Fig. 7: Energy Community Treaty signed in 2005 extends the Internal Energy
Market of the European Union towards South-East Europe
[4] L. Hancher: Slow and not so sure:
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Les auteurs
Leonardo Meeus
received a master
degree in commercial
engineering in 2002
and the Ph.D. degree in
electrical engineering
in 2006, both from the
KULeuven, Belgium.
Currently, he is a senior
researcher of the
KULeuven Electric
Energy Research Group ELECTA. He is also
the scientific coordinator of the KULeuven
Energy Institute and the European Energy
Institute (EEI). Since 2006, he is the chair-
man of the CIGRE Task Force C5-7.1 on
power system investment incentives in a mar-
ket environment.
Ronnie Belmans
received the M.S.
degree in electrical
engineering in 1979,
the Ph.D. in 1984, and
the Special Doctorate in
1989 from the
K.U.Leuven, Belgium
and the Habilitierung
from the RWTH,
Aachen, Germany, in
1993. Currently, he is full professor with
K.U.Leuven, teaching electrical machines
and variable speed drives. He is apointed vis-
iting professor at Imperial College in London.
He is also President of UIE. He was with the
Laboratory for Electrical Machines of the
RWTH, Aachen, Germany (Von Humboldt
Fellow, Oct.88-Sept.89). Oct.89-Sept.90,
he was visiting associate professor at Mc
Master University, Hamilton, Ont., Canada.
During the academic year 1995-1996 he
occupied the Chair at the London University,
offered by the Anglo-Belgian Society. Dr.
Belmans is a fellow of the IEEE and the IEE
(United Kingdom). He is the chairman of the
board of Elia, the Belgian transmission grid
operator.