Expert talk: Towards a single and well-interconnected electricity market in Europe

A fundamental challenge that comes with power flows is that we cannot simply force electricity to flow directly from point A to point B¹. Instead, it will flow through a complex network, the grid, of parallel lines following the laws of physics as discovered by Kirchhoff. Each element in the grid has a limited capacity that cannot be exceeded for the sake of stability, safety and reliability.

Consider the figure below as an example. Trade of electricity within zone 2 from North to South will, according to Kirchoff’s laws, result in physical flows through zone 1 and zone 3, which we call loop flows. As a result, less transmission capacity in zone 1 and 3 can be used for trade. Hence, there is a disconnect between commercial and physical flows: the commercial transmission capacity is lower than the physical transmission capacity.

Considering the constraints from the grid in wholesale electricity markets is a challenge. Flow-based market coupling is for the time being the target methodology of the EU to include these constraints in the procedure to settle the wholesale market. It has been in place in Central-Western Europe (Belgium, The Netherlands, France, Germany, Luxembourg and Austria) since 2015 and was recently extended towards Eastern Europe on June 9, 2022 [1].

The TSOs play a crucial role in in this process as they need to determine the commercial transmission capacity of each critical transmission line. The flow-based methodology says that the commercial transmission capacity (Remaining Available Margin, RAM) is what is left from the physical (thermal) transmission capacity after deduction of uncertainty margin(s) and an estimate of physical non-commercial flows. The latter are predictive and therefore prone to uncertainties [2].

The challenges are twofold. Firstly, there exists freedom for TSOs to determine the commercial transmission capacities which poses a trade-off. Higher commercial transmission capacity increases the economic efficiency in the wholesale market but puts stresses on the real-time reliability of the grid because it could induce grid congestion, and vice versa [3].

Two regulatory measures currently exist as a response to this trade-off. On the one hand, regulation requires a commercial transmission capacity of 70% of the physical (thermal) capacity by 2025 in the EU [4]. However, this is not the result of a techno-economic analysis and should be in a more dynamic and clearly specified way.  Moreover, high loop flows through a zone might prevent TSOs from achieving 70%. For example, loop flows through Belgium (e.g., as a result of trade within Germany or between Germany and France) at the Belgian-Dutch border are of the same order of magnitude as commercial trade between Belgium and The Netherlands [5].

On the other hand, incentive regulation has the potential for a holistic approach [6]. For example, CREG incentivizes Elia in Belgium with multiple building blocks; more commercial transmission capacity is rewarded while excessive congestion costs are linearly penalized [7].

A second major challenge is the market zone configuration (figure from [8]). Specifically, current market zones are too large, resulting in improper price signals to market participants. Price differences among market zones trigger investments in increased transmission capacity and zones with relatively high prices trigger investments in generation capacity. In a too large bidding zone the lack of any price differentiation within the zones hides the need for investments in sufficient detail. Moreover, if such a large bidding zone has a border with a number of other zones, it may result in large loop flows reducing the commercial transmission capacities including cross-border exchanges (e.g., German border with The Netherlands-Belgium-France or with Poland-Czech Republic-Austria).  In Europe, there exist large market zones of which a split into several bidding zones would be beneficial for the economic efficiency of the European wholesale markets [9]. However, this splitting of a country-based bidding zone into smaller zones, is politically not straightforward and often leads to severe discussions.

In some regions outside Europe, an even more granular approach is used, being nodal pricing, where each grid node comes with an individual price for producers and consumers attached to that node, based on local circumstances of production/consumption and grid congestion. Examples are the US states of New Jersey and Pennsylvania. It is well-known from research that such a nodal pricing mechanism outperforms the zonal pricing mechanism that European countries adopt.

There are exciting times ahead concerning cross-border trade of electricity. European stakeholders will have to deal with regulatory concerns on determining commercial transmission capacities in our electricity markets. It is unsure whether current initiatives will prove sufficient given the large loop flows we observe. Moreover, the political discussion on more drastic interventions, like splitting bidding zones or implementing nodal pricing mechanisms like in parts of the US, will only intensify.