EMERGING MARKETS DIRECT

 | 

IULIAN ERNST

  |  27.06.2013

EU internal energy market – why benefits exceed costs?

Because low prices on the day-ahead-market these days are not a guarantee that black-outs will not happen in the coming years. Because local power companies, be them in the generation, transmission, distribution or trading business, need larger markets to optimise their operations.

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EMERGING MARKETS DIRECT

IULIAN ERNST

IULIAN ERNST

RESEARCH ANALYST INTELLINEWS at EMERGING MARKETS DIRECT

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Because low, regulated prices means not social protection -- but waste of resources inefficiently allocated. Because corrupt governments owning and spending natural resources to win elections typically deliver less wealth than efficient government managing properly the natural resources. Because natural resources are limited thus unable to indefinitely offset the weak productivity of labour and capital. Because we are Europeans.

 

The challenges faced by the power market integration in South Eastern Europe are various and the threats are more visible than the benefits, particularly under a short-term analysis. There is nevertheless no doubt that i. day-ahead electricity market coupling should be realised as soon as possible price coupling with Central-East European Region, ii. domestic market should be strengthened by one or more OTC floors for trading of future contracts and iii. the trade barriers [import/export fees] should be lowered as much as possible -- if the intrinsic potential of the country’s energy industry is to be grasped. There was little progress in each of these three areas over the past months [if not years] and the time is running out. Not only that the EU set 2014 as the deadline for completing the internal energy market, but the national energy markets are already re-shaping themselves in the region and Romania risk losing more opportunities than it can afford. Bulgaria’s even weaker performance in this regard is hardly encouraging.

 

The long-term benefits of integration are so tangible that can hardly be ignored: primarily, a much larger market made available to investors, which are particularly needed on the transmission infrastructure side but also in the generation area. Short-term obstacles are however significant and some of them are more visible at the level of superficial analysis prevailing in public debates. Losing the control over natural resources ranks high on the list, amid nationalist rhetoric of politicians. But the governments’ failure in properly capitalising on the natural resources endowment and particularly on providing public goods should not hide the benefits of a common internal market. An appropriate structure of royalties and/or production sharing agreements should in principle be able to provide the government with the means to offer at least the same social protection it has used to offer under the regulates prices system. And free markets will furthermore guarantee a better allocation of the resources. The political and legal obstacles are however not negligible. Long-term limitations are also real, originating from slow economic convergence of the region toward core European Union countries, hence moderate rise in regional energy demand. Effects of ambitious renewable energy targets at EU levels, even if adjusted in the years to come, are already visible on the energy-intensive industries. Given the smaller size of the regional markets in South Eastern Europe, investments in infrastructure are less profitable financially – even if they are profitable economically. Temporary shrinking demand and the cost of renewable energy grid integration are obstacles hardly encouraging countries to seek opening their markets at this moment. On the opposite, they rather support the nationalist rhetoric of those seeking local solutions to their problems.

 

And yet, the stability of prices, security of supply and better environment for investments are long-term benefits that cannot be achieved without integration and by far exceed the short-term costs of certain one-off rise in prices.

 

Reaching full-fledged EU internal market for energy in the region by 2014 seems an unrealistic target for Romania and Bulgaria. Still, major breakthrough might be achieved in the case of Romania with rather moderate resources backed however by sound commitment for the values of a single energy market. A reasonable resolution of the renewable energy dilemma, the coupling with the short-term electricity market of Central and eastern Europe [Czech Republic, Slovak Republic, Hungary] and the beginning of natural gas trading are within the reach of the government and market regulator ANRE. 

 

POLICY UPDATE

 

Government’s conduct in regard to the energy policy is better than its rhetoric, yet the executive needs to become more active. More technical rhetoric would bring multiple, tangible benefits. Aggressive statements are harmful particularly in such a delicate context. A large number of issues are still unanswered.

 

The government’s move of supporting to some extent coal-fired holdings Oltenia and Hunedoara were broadly criticised as being in fact state aid – in its legal sense or in a more general sense. Without going into much detail, we believe however that the move has not hurt the market functioning. The criticism expressed by market-oriented analysts was driven by the general view that “coal is bad”. We believe rather that the corrupt management of coal companies in Romania bad and the companies’ losses should not be attributed to the technology without further analysis [more than quoting the production costs calculated by the corrupt managements]. More coal-fired plants are being built around us while other gas-fired generators face problems.

 

The resolution of the renewable energy overcompensation issue, as puzzling as it might seem, is actually a workable solution to the extent it gets EU’s permission quickly. Last-minute adjustments before enforcement might be given to the bill, since key stipulations are deferred until EC approves  them. We believe ANRE should be invited by the government to contribute to the evaluation of the impact quickly. Other way, further delays would be very costly for both investors and the market. The government has endorsed under emergency ordinance procedure amendments to law 220/2008 on the renewable energy support system. The draft was not officially released at the time we comment on it. The enforcement of the ordinance remains however uncertain, as ordinance’s version as published in April by the ministry of economy indicates that those stipulations that are part of the renewable energy mechanism endorsed by the EC are deferred until the Commission endorses their modification. In fact, most of the ordinance’s stipulations refer to the renewable energy support mechanism. No interpretation on this stipulation was provided by the government yet.

 

But in principle, the postponement of a certain number of green certificates acts as retroactive correction for overcompensation – a move that market regulator ANRE would not have been able to operate under law 220/2008. ANRE will further check for overcompensation twice a year – which is a better fine tuning than under prior version of the law. And if too aggressive overcompensation is carried during coming years, ANRE will have the opportunity to compensate this under the mechanism of releasing [quicker or slower] the green certificates frozen meanwhile.

 

The main stipulations of the emergency, as announced by the government on its website are:

i. capping the licensing of RES-E generation capacities under the support system, in line with the targets set under the National Action plan for the support of renewable energy;

ii. postponing the issuance of part of the tradable green certificates to entitled recipients, licensed generators that sue renewable resources. The stipulation is enforced as of July 2013 for new micro hydro, solar and wind power facilities. The number of certificates to be frozen is 1 for micro-hydro and wind [from 3 and 2 respectively, currently] and 2 for solar [from 6 currently]. The frozen certificates are to be issued starting March 2017 for solar and small hydro and January 2018 for wind.

iii. Market regulator will run twice a year checks for overcompensations – aimed at establishing whether power generators realise profitability above the targets set in the law. In case overcompensation is found, the number of tradable certificates [for investors commissioning the plants in the future] is cut down accordingly. Notably, the amended text specifies that the correction for overcompensation will be enforced immediately [and not with a delay, as stipulated in the prior version]. 

 

We expect quick resolution of a number of problems, some of which are within the reach of the government. One is the electricity market coupling with Czech-based Central European day-ahead region. Latest official information dates from January 2013, when Transelectrica’s officials signed some agreements with the existing Czech Republic – Slovak Republic – Hungary officials. But since the negotiations took already years, it is unsure whether anything will happen quickly. However, after several months of operations, the common short-term market in the three countries proved functional and Romania [plus Poland] joining it would be the next logical step as part of the EU policy. Another issue that needs quick fix is setting up of an OTC trading floor for future contracts. Indeed, the market operated by OPCOM already offers the facility to trade longer-term contracts but for some reasons it is not particularly used by market players that urge the establishment of a genuine OTC floor. In time, the floor at OPCOM will hopefully get more populated as the market deepens. ANRE has prepared draft bill for an OTC market in January 2013, but the initiative was not completed yet. 

 

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