Meeting Sweden s current and future challenges

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1 1 Meeting Sweden s current and future challenges Thank you for the opportunity for me to share some thoughts regarding the future challenges that the electricity market faces. Let me first say that the debate in Sweden about the challenges tend to focus on Sweden as some kind of isolated island. I think that this focus is wrong and that it is important to stress that the challenges, as well as the solutions, are by no means just national. These challenges and solutions are to a very high degree the same among many EU Member States. Lately the words change in market design has been on everyone s lips, both nationally, regionally and in the EU. But the questions are; do we really need profound changes, what kind of changes are we talking about and what are the drawbacks if changes mean deviating from already existing market based solutions? I will try to answer some of those questions and give you The Swedish Energy Inspectorates and my view on how we can adapt to new realities and at the same time preserve well-functioning markets. Let me start with some words regarding the Nordic electricity market. In my view the deregulated Nordic energy only market has served us well. The current design has evolved over the past twenty years and is still evolving in order to make the market more efficient to the benefit of society. The key objective over the years has been to stick to basic market principles. The development has been a result of allowing correct price signals as well as letting the market players be deeply involved in the developments of the market. As a result the Nordic countries and especially Sweden are very extensively interconnected with each other and with neighboring countries. Sweden has an interconnection ratio of over 30 percent and is at the moment a large net exporter of electricity. Last year exports reached an all-time high of more than 20 TWh in net export, mainly to Finland. More interconnectors are also under way. Connecting the EU Member States physically is in fact one of the main goals for the EU Internal Electricity Market and Sweden has a real advantage here. Other Member States, like for example the Baltics, struggle to reach the EU 10 percent target. Another advantage for Sweden is the well-functioning market. Prices reflect supply and demand both on wholesale and on retail level, wherefore the deregulation has been successful. Part of the success is also that Swedish consumers are more active and less vulnerable compared to their EU peers. Do we really need to even talk about change when everything seems to work just fine? Well, we all know that there are other objectives for energy markets as well, especially climate goals and EU integration. One big change already underway is the aim to integrate Europe s wholesale markets through binding rules, so called network codes and guidelines. The majority of those rules will enter into force within this year or the next. The implementation process sometimes calls for changes nationally within the Nordic Region even though the Nordic Energy Market have often served as a raw model for how the market should be arranged, with the main ingredients such as the day ahead and intraday markets already in place

2 2 The pace towards EU integration is however fairly slow and in some areas, like retail markets, integration is non-existent. In fact, some would claim that the EU is actually drifting apart. The European Commission has therefore decided that the current market design needs to be developed further, and especially further harmonized. The commission will present something regarding this during the winter and we expect that it will adopt many of the ideas that was presented in European Energy Regulators so called Bridge to In the Bridge paper we have identified areas in the market design that need to be reconsidered or considered further if we all are to meet the new challenges. Among our suggestions we have identified improved market conditions for demand response as a key to success. This is something that I would like to return to when I address the possible solutions. But why are EUs markets drifting apart and why are we talking about changes in market design? I think one of the main problems is that electricity wholesale prices have fallen substantially over the past years, and that this appears to be a long lasting trend. This has happened despite market driven investments having been rare over the last 5-10 years. Instead, the substantial capacity surplus has been developed due to investments in subsidized renewables. Many also see the market players decommissioning of nuclear power plants as evidence of the deficiencies of the energy only market. Of course these fears should not be ignored but we need to remember the logic behind. Electricity prices are low due to too much available power production given targeted support. Thus he main drivers are subsidies affecting profitability negatively, not the energy only market as such. If we believe that our electricity market design supports a well-functioning electricity market, the closing of non-economically viable power production is not only rational but also evidence of a well-functioning market design. The increase in variable renewable production is of course in line with EU goals and the broad Swedish Energy Policy Agreement that was concluded in June this year, and which aims at 100 percent renewables in 2040, followed by higher ambitions in the existing support scheme. With a larger and larger share of variable production we risk capacity constraints at peak hours even though our production mix also has a high degree of hydro. Therefore, the answer to the question if we need to talk about change is, yes we do. What kind of change are we talking about? Parties all over Europe have started to fear that the market design based on energy only will not give the market players return on their investments in the long run, and that politicians will not allow the market to work, meaning that customers will not be exposed to the high prices in a shortage situation. Quite a few have therefore called for capacity mechanisms and/or other political intervention as a solution to the problem. A route towards capacity mechanisms will however put the current energy only market design at risk or even out of play. Such mechanisms can be created in many different ways, but essentially they intend to secure that a power producer will be paid even though the electricity is not sold on the market or at a price that, together with additional subsidy, provide long-run profitability. All capacity payments will, in one way or another, distort price signals. That may also lead to both over- and under-investments in power generation, which will make electricity more expensive in the long run as a consequence of inefficient investment levels. It could also jeopardize security of supply since power might not be built where it would have been most cost efficient and needed

3 3 the most. Moreover, if we introduce separate systems for capacity remuneration, and the level of capacity is decided not by the market but outside the market, we will enter the road of re-regulation of the electricity market. Some say that this could be avoided by market based capacity payment solutions (predefined capacity levels decided by capacity auctions), but as soon as price and capacity are not set by the market itself we move away from market based solutions. This does not, in my view, benefit neither consumers nor society. Why do many players call for such drastic actions? I think part of the problem lies in the fact that we need to address climate change, lack of full EU integration and the challenges with variable production at the same time, and that this creates a lot of questions concerning what the future will look like. We should also not forget that some of the players who call for capacity payments are large producers that would benefit from such arrangements financially. That being said, the arguments from the people who fear lack of investments in base load power production and capacity problems should not be ignored. We all need to be confident that our current or perhaps updated energy only market delivers enough capacity in constrained situations also in To be able to evaluate what kind of measures we need to take in order for the market to deliver enough capacity in constrained situations, without distorting fundamental market basics, we need to base our policy decisions on the best possible basis, or at least on as good estimations as possible. In order to predict how our current market design affect the investments in the coming years the Energy Markets Inspectorate is currently performing several scenario analysis of the Swedish electricity market up to These analysis together with our main findings will be presented to government later this year. As a starting point, we address three main scenarios. The scenarios are based on different assumptions regarding the energy mix that we could have in 2020 and 2030; both with and without nuclear power plants. We also assume different levels of variable production. I would now like to show you some findings from the simulations.

4 4 Above you find the generation- and consumption-levels in the three scenarios that we have chosen for The first scenario is something that we call the nuclear phase out. Here nuclear is phased out due to political decisions and replaced by massive investments in renewable energy sources. The second and third scenario are inspired by the Swedish Energy Policy Agreement that was concluded in June this year. We have one scenario according to the Policy agreement, with high CO2, coal and gas prices. Finally we have one scenario with the same Policy agreement but with low CO2 prices and low alternative fuel prices. In both Policy agreement scenarios we assume that the tax on nuclear power is abolished and that the ambitions for renewables have increased with 18 TWh, just like the agreement foresees. Apart from different assumptions concerning CO2 prices we also have different assumptions on how much nuclear that will remain in the system. In the scenario with high CO2 prices we assume that six nuclear reactors remain while only two reactors are in operation in the scenario with low CO2 prices. For simplicity, consumption is assumed to be the same across all the scenarios, 142 TWh. The modelled future looks different among the three scenarios. For the scenario Nuclear phase out the yearly balance shows a minor net export of 2 TWh. Export is also expected in both Policy agreement scenarios, in one much more than the other. In the Policy agreement with high CO2 prices the net export is 39 TWh, and in the last scenario 8 TWh. The need for transmission capacity to be available is evident.

5 5 This picture shows estimated average prices in Sweden across the scenarios for In Nuclear phase out we see overall high electricity prices, which is not only a result of decommissioned nuclear capacity, but also due to high CO2 prices. As you can see the yearly average prices differ between the scenarios. Prices are the highest in the Nuclear phase out scenario, in average 58 EUR per MWh, followed by 48 EUR per MWh in the Policy agreement with high CO2. Lowest prices are found in the scenario with low CO2 prices, 30 EUR per MWh. In terms of volatility the nuclear phase out is the most volatile while the Policy agreement with low CO2 prices is the least volatile scenario. What about the need for import in constrained situations? We have also looked into the nature of price spikes, how often they would occur and how high they could become. To begin with, according to our simulations there are not a lot of price spikes. We have looked into how high prices can reach during the peaks. In the Nuclear phase scenario there are 53 hours with a price above 100 EUR. This is the scenario with the highest price spikes. In the scenario Policy agreement with high prices there are 22 hours with a price above 100 EUR and in the final scenario there are fewer price spikes, only 4 hours above 100 Euro. We also see zero prices in all scenarios. Most hours with zero prices are found in the Policy Agreement with high CO2. There are actually more hours with zero prices than hours with price spikes. As for the hours with high prices these occur during peak load situations. Our analysis show that we then need to import. The level of import varies with the different scenarios. If we assume that we reach the same peak load level as to day, about MW, the import needs will be roughly 600 MW with six nuclear reactors remaining and MW without any nuclear at all. If extremely cold weather would occur, the import would increase in all scenarios with an extra MW. The scenario analysis show that we will be more dependent on cross border trade in the future, especially in certain scenarios and in peak load situations where the simulations

6 6 indicate a need for import. This means that we need to focus on enhancing trade between the European countries. However, in order to achieve this we need to ensure that actual transmission capacity is available between bidding zones. Providing the market with all transmission capacity so that undistorted scarcity signals can be established is a key to well-functioning markets. We all know that that capacity is often restricted, especially between the Nordic region and Germany, due to internal bottlenecks in Germany. If congestions still are pushed to national borders in the future this will jeopardize security of supply and result in inefficient resource utilization, which is costly for society. Those problems therefore need to be addressed and we need to enforce already adopted EU regulation and if necessary adopt even more stringent EU rules for bidding zone configuration and congestion management. Would it be realistic to be so dependent on other countries when it comes to security of energy supply? Well, the answer is yes. We need to trust each other if we believe in an integrated EU market with all the benefits that it will bring. However, it is not enough to facilitate further cross border trade, we also need to consider a variety of measures to strengthen the market, both at national and at the European level. As I said in the beginning, I think that the current Nordic market design has served us well and that we should try to stick to our market based approach based on an energy only market where price signals incentives producers and consumers to make well informed choices. But I also think that we can upgrade the market design so that it functions better and is fit for its purpose also in the future. Demand side response is often mentioned as a socio economic way to handle peak load situations. We therefore need to introduce concrete and well-designed market rules for demand response so that demand can compete on equal terms with production. Another area where the market design needs change is related to exchange of information. This development has already begun and in a few years time we will see information hubs on the market. Some countries, not Sweden, at least not yet, also have regulated prices, and it goes without saying that those must be abandoned since they distort price signals. We also know that the same goes for targeted taxes on specific energy sources. We also believe that we should consider phasing out support for mature technologies. My conclusion is that the remedy to the challenges we are facing is not capacity payments. Instead the recipe is to increase cooperation between member states in order to further facilitate cross border trade and to facilitate demand side response. This will develop the energy market model that we already have in the Nordic Region, which has proved delivering benefits to society.