Research area #2

The organization, structural change and regulation of electricity markets in Europe with special attention given to the design and implementation of capacity market and the use of long-term contracts.

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About the research area

Axis 2 is at the heart of the Chaire on European Electricity Markets. The main added value of the work of the Chaire must consist in their contribution to a better understanding of the structural changes and regulations of the European electricity markets. This improved understanding should emerge from academic works that formalizes, models and analyses electricity markets issues with the methodologies stemming from industrial economics, game theory and institutional economics. The challenge of this formalization is to express adequately the strategies of actors in an environment characterized by strong institutional and technical constraints. Particular attention will be paid to information asymmetries and market microstructures. The players whose strategies will define the final equilibria are not only industrial enterprises but also electricity regulators, the European Commission and national governments.

With the NOME in France, the law on renewable energies (EEG) and an unilateral nuclear phase-out in Germany and the "White Paper" on electricity market reform in the United Kingdom, three major European countries have undertaken important new initiatives to reshape their respective electricity industries, which is sparking tensions with economic logic as well as intensive internal and external debates. The Chaire EEM will participate in these discussions as a source of analysis. Its methodological approach will be strictly “positive”, while recognizing that the electricity sector cannot exist in a political and social vacuum. Its role will be to facilitate discussions through economic analysis and thus eventually to contribute to the emergence of a common European electricity. The value of the Chaire will be characterized by formalized institutional analysis. Five research areas are emerging in this context:

1. The arrival of significant amounts of electricity generated from intermittent renewable energy generates important impacts at all levels of the electricity system that require attentive study. These include (a) the additional cost of their connection especially for off-shore wind, (b) strengthening internal networks following the de-optimization of the system with an increasing gap between places of production and consumption, (c) the constitution of sufficient reserves of dispatchable technologies to meet the uncertainties of intermittent production, (d) the constitution of sufficient reserves of dispatchable generation capacity to meet peaks in daily and seasonal demand, (e) the decrease in load factors (compression effect) and average electricity prices that affect the profitability of dispatchable technologies, making it more difficult to stimulate new investment and maintaining security of electricity supply.

2. Capacity markets, including their design, operation and coordination will be another research area of the Chaire EEM. They will respond at least in part to inadequate investment incentives for dispatchable generation capacity. The work will focus on three dimensions of capacity markets (a) the efficiency of different types of capacity mechanisms (generalized or targeted mechanisms, centralized auctions or fixed payments etc..), (b) their integration and interaction with “energy only” markets and (c) the need to harmonize capacity mechanisms across European countries to take advantage of market linkages and pool the advantages of developing flexible equipment in each country.

3. The work of axis 2 will also include analyzing the appropriate conditions for long-term contracts (including "contracts for differences", tariffs or premiums purchase and production transfers at regulated prices) to be rehabilitated and integrated into liberalized markets while maintaining economic efficiency and free entry. This discussion will take place in the context of increasing tensions between the objective of creating a competitive European power market (supported by competition policies reflexively opposed to long-term contracts) and European targets to reduce greenhouse gas greenhouse gases in the electricity sector (Roadmap 2050). Achieving these ambitions demand the widespread deployment of low carbon technologies (nuclear, renewable and CCS). Yet all of these are characterized by high fixed costs that require risk sharing between producers, consumers and public authorities. Beyond the analysis of the efficiency of long-term contracts, the work of the CEEM will also concentrate on the convergence of different national initiatives seeking to combine competitive electricity markets with social and environmental objectives.

4. In the present context, the study of the integration of European electricity markets is essential. This will include a first quantitative study of the actual degree of convergence between markets and the prospects for more advanced convergence in the medium term. This will also include the analysis of remaining barriers, be they physical (such as limited interconnection capacity) or institutional. Regarding the financing of interconnections, the Chaire will undertake a cost-benefit analysis to compare the efficiency gains resulting from market integration with the cost of constructing additional interconnection capacity.

5. In a more traditional manner, the Chaire will seek to contribute to the emergence of a concept of market power relevant to electricity markets where the inelasticity of production and consumption can generate “spontaneous” market power that is difficult to distinguish from pricing power due to voluntary capacity retention. The study of scale economies (such as the ability to share fixed costs over different markets), risk management and information asymmetries and transaction costs inside and outside of the company will also contribute to this important objective.

The work of the axis 2 constituting the central concern of the Chaire, it is expected that it will benefit in particular from the contributions and expertise of the Chaire’s partners.

The annual commitments of axis 2:
- The publication of two articles with a formal analysis of the evolution of European electricity markets in peer-reviewed journals;
- An international seminar on European electricity markets issues that will permit expert discussion between academics, market participants and regulators;
- Ad hoc meetings upon request of the partners on issues that require a quick and informal exchange of perspectives;
- The integration of a PhD student whose research focuses on the organization of European electricity markets.