Energy Union – towards planned or market economy?

In many other policy fields the EU strives for more market-based approaches - but not in the energy sector. Tellervo Kylä-Harakka-Ruonala, member at the European Economic and Social Committee, elaborates on the paradox of EU energy market.

Tellervo Kylä-Harakka-Ruonala, a member at EESC, has a long experience at the Confederation of Finnish Industries (EK) in the areas of energy, infrastructure and environment.

Energy has become quite a curious commodity. In many other policy fields we have moved towards more market-based approaches – but not in the energy sector. On the contrary, the European Union is approaching an energy world where everything is either regulated or subsidised and where free competition is far from reality.

Market design top down

The basic objectives of EU energy policy are still valid: to ensure the security of supply and to enhance competitiveness. But what is the new element? It is not the challenge of climate change abatement for it has been there for decades already. The new fact is that markets do not provide proper signals to producers and consumers. This is particularly true as far as electricity is concerned. And this is why the new concept of “market design” has been introduced.

Market design actually includes an internal contradiction. To design the market is to plan the economy, which again undermines markets. In a planned economy the way and amount of production and consumption are tried to be determined top down.

Spiral of increased subsidies

Renewable energy lies in the center of the Energy Union because it contributes to decreasing the dependency on foreign energy sources and to combating climate change. Renewable energy has been so far enhanced by substantial subsidies. Consequently, the rapid increase in intermittent electricity production has led to a situation where back up capacity – generally fossil based – has to be subsidised, too, in order to safeguard the security of supply.

What would then be an altenative approach? It seems that nobody has clear and exhaustive answers. However, if we want to get rid of the spiral of increasing subsidies we should rely more on competition and innovation. This does not mean that one can live without any political guidance. For example climate change objectives are there to stay. But political decision-makers should avoid micro-management and instead, only set boundary conditions like the emissions targets.

Room for market mechanisms needed

Considering energy as a publicly owned and financed service would not be the right solution, neither. It would rather mean going backwards in the history. Instead, one should strive for utilising market mechanisms more effectively and get demand and supply to meet each other in a better way.

Roughly speaking, we can proceed along two parallel routes: Firstly, the prices paid by customers should reflect the costs of the energy system as completely as possible, including the external costs of carbon dioxide emissions. Secondly, more investment has to be focused on research, development and innovation on new low carbon technologies. The basic idea is to get production costs so low that there is a business case even in the conditions of low energy prices.

But in any case, prices should be allowed to be determined in the markets through competition. Political decision-makers do not have the wisdom to determine the “right” structure and amount of energy production and consumption nor to forecast the production costs and the consequent prices. The only exemption is the pricing of external costs. For example, the price of carbon emissions is inevitably based on political decisions such as decisions on emissions trading or taxation.

Consumers becoming “prosumers”

Furthermore, one should strengthen customer-oriented thinking, be the customers companies or individual consumers. This is how business works in other sectors. The role of consumers is in any case increasing in energy systems, both as managers of energy demand and as energy producers. In other words, consumers are becoming “prosumers”. True demand-side management requires that electricity pricing is based on a real-time information on the consumption. This again calls for the introduction of smart systems, remote readable meters being the heart of the system. Finland is a forerunner in the EU having this kind of metering and pricing model in use.

All in all, new energy market design is not only a matter of details of infrastructure or trading. Instead, we are talking about fundamental principles of our energy future. This discussion must not be missed but feeded actively with various views to be elaborated further.