Arthur Cox: evolution or revolution?

Alan Bissett and David Trethowan emphasise the need for the main energy sectors to comply with EU law.

The European energy market is the last large scale market which has not been widely harmonised to date. This is unsurprising due to the vastness of the market and its highly technical nature. The EU Third Energy Package, which is made up of a series of directives and regulations, forms a regulatory framework designed to reinvigorate the integration of the European energy markets for electricity and gas.

Aims and goals

It is hoped that the implementation of the Third Package will go some way to meeting the EU targets for 2020 which aim to secure a 20 per cent reduction in greenhouse gases, a 20 per cent reduction in demand and a 20 per cent energy mix of renewables across Europe.

Additionally, the Third Package aims to safeguard consumer interests and promote market competition by providing consumers with the ability to quickly change suppliers and to prevent discrimination in the use of networks by requiring the separation of transmission system interests from those of supply and generation. It also provides for the functional independence of national regulators, such as the NIAUR and the CER.

The process of large scale integration

The logistical problems associated with such wide scale integration are being tackled through the promotion of regional initiatives. The expectation is that by achieving regional integration in the first instance, the wider process of harmonisation will be accelerated by a coordinated approach to the introduction of network codes for cross border flows of energy.

Locally, regional cooperation is being implemented for electricity through the France-UK-Ireland (FUI) regional initiative and for gas through the North West (NW) regional initiative with the process of integration being overseen by ACER, the new European energy body.

Electricity market interconnection

For electricity, the liberalised market will be provided through increased interconnection, with energy flowing from areas of surplus to deficiency in the most competitive way, resulting in reduced energy costs for consumers and increased security of supply.

Initially, large scale investment in infrastructure will be required with significant additional interconnector capacity needed to ensure the unabated flow of electricity. This is of particular importance given the intention to increase the percentage of renewable generation in the energy mix.

Future network infrastructure must be able to cope with increased levels of intermittent generation with there being a risk of higher levels of curtailment and constraint if necessary upgrades are not made. Associated with this is the need to roll out smart grids to predict and intelligently respond to market demands.

These changes will also be delivered through the introduction of harmonised network codes which will deliver a target market model that will be automatically binding to create unified capacity and congestion management codes.

Issues for the SEM

The island of Ireland has had an all-island electricity market since the introduction of the SEM in November 2007. The SEM market trading arrangements are markedly different from those in the other FUI regions, being based on a gross mandatory pool market with day-ahead gate closure and ex-post pricing. There is currently no physical day-ahead or intra-day trading in the design.

The Third Package target model includes flow based market coupling for day-ahead trading, in which cross-border capacity is made available implicitly by means of energy transactions through power exchanges.

Important features in the SEM market design are incompatible with this day-ahead trading model. For example, there is no firm day-ahead price, the SEM is scheduled and dispatched centrally, it provides for explicit capacity payments and it has longer gate closure times. Also, robust arrangements are required for intra-day trading which is seen as critical for systems with a high proportion of intermittent supply through the use of renewables.

In this regard, transitional market arrangements may be put in place by 2014. Many see a two-phased approach as the fastest way to move to full compliance with the introduction of arrangements for day-ahead and intra-day markets with central dispatch. However, certain specified criteria must be met and demonstrated to ACER before this will be permitted.

Others believe that it may be best to concentrate on putting into place final measures by 2016, when an enduring market design is required under the Third Package obligations.

Common Arrangements for Gas

The completion of the Scotland Northern Ireland Pipeline (SNIP) gave Northern Ireland access to natural gas for the first time. Although a relatively new market, it is likely to undergo significant changes in the short to medium term with the introduction of the Common Arrangements for Gas (CAG) which are intended to provide an all-island market in gas.

Although it is still in the development phase, the regulatory authorities on both sides of the border are endeavouring to ensure that CAG is Third Package compliant. The outcome is expected to be a common network code developed to cover all transmission assets in Northern Ireland and the Republic of Ireland with short-term capacity and interruptible capacity products aligned with those network codes.

With regard to Northern Ireland, the fully postalised transmission system regime currently used is likely to change as a result. This regime results in a single tariff being charged to all users at their exit points irrespective of that exit point or the pipeline used. The Third Package requires that tariffs should reflect the actual costs incurred in using the transmission system, so it would appear that an ‘entry-exit’ point design may be adopted.

Further, as capacity on the SNIP is currently only available on an annual basis, it would appear that short term products will be required to be made available to comply with Third Package requirements. These products would be for monthly or daily entry capacities with the methodology used to calculate tariffs likely to follow the Gas Link code to maintain a level of certainly for Irish shippers and to minimise changes from a code perspective.

Our energy future: moving towards compliance

It would appear that there is a great deal of work to be done and it is no secret that the tasks ahead are challenging. However, we should move forward into this new phase of integration with some confidence.

From an electricity perspective, we have successfully integrated two wholesale markets into one before. Although the SEM is not currently compliant, some level of evolution or even revolution, is likely to be accepted by stakeholders.

In relation to gas, CAG provides us with a great opportunity to put in place a Third Package compliant system from its inception, thus providing an all-island gas market which will bring benefits to all.

Alan Bissett is the lead Partner and David Trethowan is an Associate in Arthur Cox’s Projects and Energy Group