How integrated are European electricity markets?
June 15th, 2010 by Georg Zachmann, Research Fellow, BruegelElectrons passing through international electricity networks follow the complicated physics of meshed alternating-current grids and do not respect price-zone borders. Correspondingly, scheduling power plants on the basis of national prices without taking into account the real physical networks within and between countries makes it necessary for the system operator to take non-market measures to ensure system stability . This is illustrated by two obvious inefficiencies. First, cross-border transmission lines are rarely fully utilised despite persisting price differentials. Second, electricity very often flows from high- to low-price areas . Overall, the current system is light years away from the theoretically optimal use of European power plants and transmission lines that would characterise a fully functioning single energy market.
Despite institutional progress between 2005 and 2009 , we argue, using the case of the systemically important German market , that progress has been limited in the last five years. We base our claim on three observations:
First, prices in the countries that border Germany have not converged significantly with German prices, and high hourly price differentials were common between 2005 and 2009. In the electricity market as currently structured, decreasing differences between national hourly electricity prices could be a sign of greater market efficiency and/or increasing commercially available transmission capacity. However, Nitsche et al (2009) found that German electricity spot prices in 60-90 percent of instances differed by more than five percent from the price in almost all neighbouring countries. In addition, the absolute annual average price differences in 2009 for almost all of these market combinations exceeded their corresponding 2004 value9 . Thus, recent reforms have failed to produce a consistent reduction in price differentials that would point to increasing market integration.
Second, price differentials are almost unrelated to capacity usage. In an integrated market, as long as lines are not fully used, the price differential should be zero while, as soon as congestion occurs (at full capacity), the price differential depends on the difference in marginal cost in both systems. In reality, however, electricity often flows against the price differential. In the German-Dutch case, electricity flowed from the high price area to the low price area for 49 percent of total hours in 2009 (Figure 1). At the German-French border this occurred for 46 percent of total hours. This illustrates the flaws of a system based on coupling large national zones that face internal congestion.
Third, physical interconnections have not developed substantially in recent years. Figure 2 shows the net transfer capacities from and to Germany between 2005 and 2009. While the import capacity remained constant, the export capacity decreased by more than 15 percent. The absence of progress in Germany’s cross-border transmission capacity is representative of the EU-wide picture. Between 2005 and 2009, the average net transfer import capacity of all countries in the European transmission system decreased by more than 15 percent. This is mainly due to the need for increased security margins for cross-border trade because of growing shares of intermittent renewable production. Thus, decreasing availability of cross-border transmission for commercial operations becomes an increasingly limiting factor for market integration.
In conclusion, the remaining international price differentials, the insufficient response of electricity flows to price signals and non-increasing cross-border transmission capacity demonstrate that in the last five years progress towards a single market for electricity has been limited.
Georg Zachman, Research Fellow, Bruegel
P.S. Full document is available here.
