Janez Kopač: Price caps distort the price signal and limit the ability of peaking units

Janez Kopač: Price caps distort the price signal and limit the ability of peaking units

Three months have passed since new electricity market in Ukraine was launched. The new market model would have led to the free market and competitive playing field. However, imperfect public service obligations, debts, and purchase of electricity from aggressor nation, and other concerns caused a lot of criticism by market participants. As Ukraine is an Energy Community member and should follow the best practices of European energy law, it is important that the European colleagues’ assessment be heard.

During the interview held by ExPro Electricity, Janez Kopač, the Director of the Secretariat of Energy Community, gave the overall evaluation of the introduction of liberalized electricity market. He presented his view on PSO mechanism, price caps in day-ahead and intraday markets, and pointed out what Ukraine should have done before approval of electricity import from Russia and Belarus under bilateral contracts.

1. What is your assessment of the operation of the new electricity market model in Ukraine for the first three months?

The introduction of bilateral and short-term markets was long awaited in Ukraine. The Secretariat welcomes the start of operation of the new wholesale electricity market model in the country. At the same time, we see some unresolved issues such as debts, public service obligations (PSO), cross-subsidies etc., which shall be addressed by Ukrainian authorities (Parliament, NEURC, CMU).

2. What the main problems and achievements of the new market implementation can you separate out?

Ukraine made the first steps in introducing an electricity market, but the new model was introduced with many restrictions and not all of them are complaint with European standards and practice. The current market set-up has restrictions regarding pricing on the wholesale and retail level and continues with regulated tariffs for households. The next steps shall be: the elimination of cross-subsidies; reconsidering of the public service obligations (PSOs); debts shall be solved and measures for avoiding their accumulation shall be implemented; unbundling and certification of the transmission system operator shall be finalised. Implementation of these issues requires cooperation between all responsible institutions and an independent and strong regulator.

3. Do you support current the PSO-model including state-owned generators? In your opinion, does the PSO-model encourage the development of the competitive market?

We do not support the current PSO Act. Despite the fact that the PSO Act was already amended several times, the procedure for its adoption was and is not respected. The Act should have been consulted with the Energy Community Secretariat (as is required by the Electricity Market Law) but this was never the case.

We do not support the current PSO Act

The Energy Community Secretariat addressed its concerns on the process of approval of the Regulation for imposing the PSO to the previous CMU (Prime Minister of Ukraine - Mr. Groysman) and recognised that the approved Regulation for imposing PSOs is not compliant with Energy Community law, as it goes beyond what is necessary in pursuit of the general economic interest, i.e. securing affordable electricity supply for households as universal service supply. The PSO regime is not proportionate and lacks legal certainty. We asked for the Regulation to be reconsidered.

The latest proposals announced by Minister O. Orzhel during the Committee meeting at Verkhovna Rada last week (to impose an additional PSO for CHPs through the Guaranteed Buyer) were also not consulted with the Energy Community Secretariat. We are still expecting that this process will follow the procedures set out by the Electricity Market Law.

4. What amendments to the PSO-model could your suggest taking into account under Ukrainians economic circumstances?

The Energy Community Secretariat proposed to include financial bilateral contracts, which in other countries have proven to be the best mechanism to hedge the universal service suppliers and to ensure that the potential windfall profits of the generation companies will be transferred to consumers. Instead, the PSO Act has replaced the single buyer model with auctions to which only one buyer (the Guaranteed Buyer) is allowed to participate while purchasing at a predetermined price from state owned generators.

The current PSO Act is also not compliant with the requirement stemming from the electricity acquis that the network operators (the TSO and DSOs) have to purchase electricity for covering network losses according to transparent, non-discriminatory and market-based procedures.

5. Was there a necessity to adopt prices caps in the day-ahead and intraday markets by national regulator (the National of Energy and Utility Regulation Commission)?

Is it necessary to rise or pull down prices caps, to your mind? Despite the fact that price caps are used also in other countries, including EU Member States, at the outset of organised market establishment and may be justified in an oligopolistic market such as the Ukrainian one, these measures need to be limited in time and phased out in order to stimulate participation in these market segments and allow for competition to develop.

Price caps need to be limited in time and phased out

6. Do you think should Ukraine gradually withdraw from prices caps applying in the day-ahead and intraday markets?

It should be a temporary measure, limited in time. Otherwise, such strict administrative restrictions do not allow real cost-benefit analysis of all announced ambitious projects (such as full synchronization with ENTSO-E, construction of the back-to-back connection between main IPS of Ukraine and Burstyn Island announced by Ukrenergo this summer). Also, it is a barrier for electricity market integration with neighbouring countries.

7. How should Ukraine remove prices limitation and shift to the liberalized pricing in the electrify market?

Price caps are not the only possible measure to boost competition on national wholesale markets. In May this year, the Secretariat published so-called Policy Guidelines on this issue (https://www.energy-community.org/dam/jcr:6bb112a3-526e-4ebf-b265-84d6b392241c/PG_01_2019_ECS_WM_EL.pdf).

These Policy Guidelines provide recommendations on the legal and regulatory measures that could be used to introduce competition at national level and enable cross-border trade in situations where national incumbent undertakings still dominate the national wholesale markets resulting in a situation where competition is prevented at not just the national level but also the regional/cross-border level. Some of these measures are already applied in Ukraine – the Electricity Market Law requires a compulsory sale of 10% by producers on the day-ahead market (DAM) during the first year of the DAM’s functioning.

8. Is there the experience of prices caps using throughout the developed European electricity markets?

Price caps are used also in other countries, including EU Member States. However, price caps in the EU are not used as a means to regulate organised markets, as opposed to what we are now seeing in Ukraine. Price caps distort the price signal and limit the ability of peaking units or more flexible resources to recover their capital costs, contributing to the ‘missing-money’ problem.

The guideline on capacity allocation and congestion management (Commission Regulation (EU) 2015/1222 of July 2015) designated the introduction of harmonised maximum and minimum clearing prices that contribute to the strengthening of investment conditions for secure capacity and long-term security of supply. Now these clearing prices are agreed on the level of +3000 EUR/MWh and -500 EUR/MWh.

9. What positive and negative consequences of price caps applying could you identify?

Price caps allowed Ukraine to avoid market disruptions at the very beginning - many changes in secondary legislation were introduced at the very last moment, without a proper analysis of the results such amendments could lead to.

At the same time, the proposed price caps brought additional challenges - market participants showed limited interest to trade on the DAM and the IDM, and the traded volumes declined in the first couple of weeks.

10. What is the Secretariat of the Energy Community’s attitude to recently appearing ability to import electricity from Russia and Belarus to the Ukrainian Integrated Power System under bilateral contracts?

Belarus and the Russian Federation are third countries to the Energy Community, and Ukraine, as an Energy Community Contracting Party, has the right to set rules and criteria regarding third parties as long as the trade among the Energy Community Contracting Parties is not affected. Of course, a country should analyse if it brings any risks to its market and its security of electricity supply. Any potential risks should be assessed in the security of supply monitoring process. This was not done yet.

Dmytro Sydorov