Why regulatory intervention is needed for electricity markets

12 June, 2019 | Posted By: Andreas Poullikkas

The transition from structured monopolies to free electricity markets, aiming at full competitiveness in electricity generation and electricity supply, creates challenges that often require regulatory intervention.

The purpose of intervention focuses on ensuring a smooth transition from the old regime to a fully competitive market structure in terms of tariffs, adequacy, investment sustainability and reliability of the electricity system.

For example, the way in which the electricity sector is structured has gradually evolved from a vertically integrated state monopoly into a set of entities that produce and supply electricity within a competitive electricity market, completely detached from the management of the transmission and distribution system.

However, electricity markets must continue to provide reliable and secure electricity at affordable prices and with respect to the environment.

As a rule, investors new to the field want to see low costs and a sufficient degree of certainty as to the recovery of their initial capital.

There should be a positive expectation of revenue from the retail and wholesale markets for newcomers to invest.

From the point of view of a new investor, the key uncertainties to be addressed concern (a) the risk of overcapacity (b) the ability to create a customer base and (c) the fundamental economic sizes regarding the competitiveness of the new investment in the future market.

Eradicating all or part of these uncertainties is the aim of regulatory intervention.

Before a regulatory decision is taken, it is necessary to ascertain whether actual market conditions can lead to an increase of market integration but also meets expectations regarding the security of supply, cost and the protection of the environment.

By definition, regulatory intervention is a non-market measure and usually has asymmetric consequences for market participants.

For this reason, the assessment of the impact of any intervention should balance the effectiveness of the measure and limit market distortions.

With regulatory intervention being a non-market measure, full cost-effectiveness cannot always be achieved and therefore any remaining balance is borne by market participants and ultimately by consumers.

Therefore, the challenge is to orientate intervention on an outcome which would have been generated by a purely competitive market and to minimize the cost of inefficiency, primarily from the point of view of consumers.

Regulatory intervention should be a last resort to be taken when there is a belief that the market cannot deliver.

Therefore, the positive external results from the intervention are expected to offset the unavoidable cost of implementing this measure.

Regulatory intervention should focus on removing barriers for new commers and tariff controls in order to progressively develop a functioning electricity market, as competition must provide a secure and reliable electricity system with the minimum financial cost for consumer.

Regulatory intervention should be transitional in order to kick-start competition in the electricity market which is expected to gradually be transformed into a functioning competitive market where the main barriers to competition will be largely eliminated.

The impact assessment must take into account the time factor and circumstances under which the intervention should end within a reasonable timeframe.

Where regulatory intervention causes long distortions, it will create disadvantages for the market.

In general, regulatory interventions are intended to influence the behaviour of players in the electricity market by providing negative or positive incentives or by ensuring the implementation of certain market operating rules.

Examples of such measures are the definition of a minimum threshold for production offers on the pre-commercial market that is equal to the cost of production fuels, the obligation to submit bids separately per unit of electricity production, etc.

These measures are designed to create conditions in the forward-looking market by fairly disclosing the underlying purchase costs and prices allowing potential investors to obtain sufficient information to assess the economic feasibility of their investment plan.

Other regulatory approaches support the introduction of transitional arrangements until the full functioning of the competitive electricity market, with incentives for alternative producers and suppliers.

In conclusion, there is always the possibility of combining different regulatory measures of a different nature.

The assessment of regulatory intervention measures should review the effectiveness of the ability to solve problems appearing, the benefits, the costs of implementation, the negative effects on competition, market players and customers, possible prolonged distortions, always in comparison with alternative options.