Mr Rabindra Nepal
The creation of a common and integrated market for electricity was and still is a major goal of the European Commission (EC). The Commission’s Directive 2003/54/EC required the member states to open the market and guarantee non-discriminatory network access to third-parties while the EU Directive 2009/72/EC placed wider emphasis on cross border-interconnections and the need to mitigate barriers to cross-border trade. As a result, electricity markets across Europe experienced liberalisation, privatisation and price deregulation so as to meet the energy policy goals and targets of sustainability, affordability and security of supply. The development of organized wholesale spot markets (i.e. the power exchanges), increased cross-border trade of electricity and more interconnections remain the major hallmarks and means of these liberalised but largely national markets aspiring to be largely integrated.
In line with changing EU policy the Northern Ireland Authority for Utility Regulation (NAIRU) and the Commissions for Energy Regulation (CER) started jointly regulating the all-island Single Electricity Market (SEM) since November 1, 2007. The goal of the Irish All-Island Market (AIM) was to increase investment in new generating plants and availability of existing generators. It includes both the Republic of Ireland and Northern Ireland. However, the isolation of the island economy from continental Europe has resulted in just one high voltage direct current (HDVC) interconnector link (i.e. the Moyle interconnector) connecting SEM with Great Britain (GB) amounting to almost 4.7% (about 500 MW) of total SEM generation capacity. The lack of greater interconnection is a real concern in a highly concentrated SEM because it may expose the market towards strategic behaviour by the incumbents leading to market power exercise and unilaterally profit from limited competition. In addition, the benefits of an integrated market also remain foregone.
It is argued that the main advantages of larger integrated markets are enhanced security of supply and a reduction in reserves needed to maintain any given level of system performance (Malaguzzi Valeri, 2009; de Nooij, 2011 ). An interconnected system is economically justifiable because it incurs lower operating costs by permitting excess supply in one node to be utilized in other nodes where the marginal cost would be higher if there were no interconnection (Charun and Morande, 1997). Thus, the potentials for capital costs reductions exists by incurring lower investments as it may no longer necessitate maintaining reserve generating capacity in every node in case of system failures (Turvey, 2006). The total economic surplus is also maximized as the most expensive energy is displaced. Integrated markets, in general, can lead to the highest social welfare than if the markets were to remain separate (Neuhoff and Newbery, 2005; Hobbs et al. 2005; Ehrenmann and Neuhoff, 2009). Interconnections can even create incentives for optimizing the size and timing of new investments by associating with a more efficient system (Brunekreeft and Newberry, 2006).
The purpose of this paper is to primarily assess the current degree of market integration between SEM against other large, mature and well-established electricity wholesale markets in Europe including Great Britain (GB) and determine the level of interconnection needed in SEM to meet the EU policy of increasing integration of electricity markets. In the process, we also estimate the gross benefits for SEM arising from international wholesale electricity price differences but by no means should be perceived as a cost-benefit analysis (CBA) of interconnection in SEM as we do not explore the costs-side and is beyond the scope of this paper. We believe that competition inherently is the main driver of lower electricity prices in Europe as implicitly underscored in the EU Directives. Hence, interconnections may be an effective way to increase competition and market integration in smaller wholesale markets with limited number of participants such as SEM (de Nooij, 2011).
Economic studies on the theoretical and numerical models of strategic behaviour further indicate that it is more costly and hence less attractive to exploit market power in an interconnected market (Amundsen et al. 1998; Van Damme, 2004). Interconnection allows generating companies abroad to compete possibly with dominant domestic generators, mitigating market power (Newbery, 2002). Interconnecting fossil dominated electricity systems such as SEM with hydro based systems could reduce price volatility and mitigate subsequent market uncertainties (Matsukawa and Mulder, 2004). A stable wholesale price, in turn, provides stability to the wholesale market which can further help in providing appropriate investment incentives and market signals to the market participants (Green, 2008). Hence, SEM may benefit through increased interconnections with other EU electricity markets in terms of enhanced competition, improved security of supply and lower electricity prices.
The results indicate a low degree of market integration between SEM and other European markets and thereby raising the possibility to benefit from increased electricity trade. As wholesale prices in SEM remain relatively high and volatile; a larger interconnector capacity can promote competition, close the gap with the European wholesale prices, improve security of supply, and mitigate price volatility. Our results remain inconclusive when examining whether increased wholesale spot trading of renewable may not increase market integration. The results suggest that an interconnector capacity amounting to about 21% of generation capacity in SEM is likely to achieve an integration coefficient of 0.86 similar to what currently exists between the markets in Austria and the Netherlands.