Filenews 16 July 2023 - by Christakis Chatzilaou
The dynamics of electricity pricing and the integration of Renewable Energy Sources (RES) are intertwined in a complex pattern, especially in small, immature and isolated electricity markets, such as Cyprus.
As the price of electricity continues to rise in Cyprus (in contrast to what is happening in the rest of Europe), causing concern among consumers, a key question emerges:
Can we change or at least influence the trajectory of this rising price, or are we doomed to much higher prices than the rest of Europe?
Although we have written and analyzed in detail the cost of electricity and the factors that affect it, it is nevertheless appropriate to further develop some aspects and provide clarifications on issues related to the role of the Competitive Electricity Market model, in relation to the integration of RES and the formation of electricity prices.
Target Model
In order to study the function of electricity price in a competitive electricity market environment, we should critically evaluate the Target Model, which has been selected for implementation, without taking into account the particularities of the small, isolated and immature Electricity Market of Cyprus.
The Target Model, which is already applied in many countries of the European Union, according to the guidelines of the European Commission, makes use of the mechanism of pricing the marginal selling price -pay as clear- per half-hour trading period (i.e. the highest electricity price included in the sales quantities) to determine the selling price.
This means that RES generation, which will participate in the Day-Ahead / Wholesale Market, will be able to submit even zero bids, but will be compensated according to the most expensive supply required to meet electricity demand.
Distortions and excessive profits
Taking seriously into account that the energy mix of Cyprus does not include electricity with low operating costs, which will reliably cover the entire demand for electricity, such as energy from electrical interconnections, hydroelectric projects, nuclear power stations, etc., it is concluded that in order to meet the demand, the participation of the conventional production of EAC or other conventional producers (which will most likely have higher production costs, due to dependence on fossil fuels and high taxes on pollutants).
This will inevitably result in RES production being compensated at the high price of conventional production and reaping superprofits from the implementation of the Target Model.
This conclusion of making superprofits from RES production is demonstrated by the partial implementation of the Target Model under the Transitional Arrangement for the Electricity Market of Cyprus.
Linking the cost of conventional production (avoidance costs) to the way RES production is compensated is already causing distortions in the price of electricity, which are mainly focused on making superprofits from RES production.
In this way, the potential benefits of increased RES penetration, such as lower production costs compared to traditional (conventional) production methods and reduced emissions, are not sufficiently exploited, thus not having an impact on the reduction of electricity prices.
The pessimism of the case is that this situation of the Electricity Market in Cyprus is expected to continue with the same pattern and will not change, both in the short and medium term, so as to allow little optimism, since even the estimate for the implementation of the electricity interconnection has been postponed to 2030.
The Target Model Falls Short
In my technocratic opinion, the Target Model, which is designed to operate and perform in larger and competitively mature electricity markets with high RES penetration, falls short in addressing the particular challenges of the Cyprus Electricity Market.
The small size of the market, the relatively low penetration of RES, the lack of interconnections, the energy mix without low operating cost technologies to reliably meet the entire demand and the high cost of conventional production and pollutants, hinder the effectiveness of the Target Model for the Electricity Market of Cyprus.
Consequently, it is estimated by many that this model, as it is planned to operate on the basis of the pay-as-clear pricing mechanism, will obviously cause a short- to medium-term increase in the price of electricity, further burdening the Cypriot consumer.
The position that the application of this model will distort the price of electricity is also reinforced by the fact that the marginal selling price pricing mechanism is based on two main assumptions.
The presence of positive marginal costs (fuel costs and opportunity costs) and the possibility of allocation (i.e. the flexibility of production units to accept orders in order to respond fully and adequately to fluctuations in demand at any time).
These two conditions are in fact insufficiently met by the RES systems (currently installed in Cyprus) and therefore render the pricing mechanism of the limit price ineffective (for these systems).
Clearing transactions every half hour
The only change that could be catalytic is in the time of the clearing of transactions, so that clearings do not take place monthly, as distortively happens under the Transitional Arrangement, but every half hour.
It is noted that the monthly settlement does not allow the development of competition, even in cases of oversupply of RES production and therefore does not contribute to the reduction of the price of electricity to the benefit of the consumer.
In conclusion, it is stated that the solution of electricity storage, which could potentially serve as a catalyst in view of the current deadlocks in the electricity system and the electricity market, is estimated that due to cost it will not be able, even in the medium term, to contribute to the reduction of the price of electricity. This solution can probably only work with a grant and government support.
The criterion of choices is the absolute benefit of the Cypriot consumer
The time for action is now, when the price of electricity is galloping. Policymakers and stakeholders in the electricity sector should coordinate to review the Target Model of the Cyprus Electricity Market so that it can work for the benefit of the Cypriot consumer.
The Target Model, as designed to operate on the basis of the pay-as-clear pricing mechanism, is estimated by many to cause a short- to medium-term increase in the price of electricity.
Distortions in the compensation of RES production already exist in the context of the implementation of this model in the Transitional Regulation for the Electricity Market. Therefore, the question arises as to why the application of a model that is admitted to cause further burden to the Cypriot consumer?
There are options for changing course. We have proposed as a possible solution the unblocking of the cost of conventional production from the compensation price of RES production, with the introduction of the pay-as-bid pricing mechanism, but there will probably be other solutions.
The future of affordable and sustainable electricity in Cyprus depends on the choices we make today.
Our criterion for these choices should be the absolute benefit of the Cypriot consumer, who requires a reduction or at least a moderation of the price of electricity.
Possible alternative: pay-as-bid pricing mechanism
An alternative to the distortions and increase in the price of electricity, caused by the Target Model, as it is designed to operate on the basis of the pay-as-clear pricing mechanism, could be the substantial modification of the Target Model or even its change, if this is deemed to be to the benefit of the Cypriot consumer.
The duration of the amendment should be rather medium-term, at least until the electricity market of Cyprus can be interconnected with the rest of the European Union markets. In this regard, it is emphasized that in the context of the substantial modification of the Target Model, it is necessary to achieve the disengagement of the cost of conventional production from the compensation price of RES production.
This unblocking, which will last as long as the cost of conventional production is higher than that of RES production, will help prevent the realization of excessive profits from RES production.
In order to achieve the goal of unblocking the cost of conventional production from the compensation price of RES production, the pay-as-bid pricing mechanism is proposed as a possible solution for reflection.
This pricing mechanism, which can obviously operate within the framework of the Target Model, allows producers to be compensated on the basis of the bids they have submitted. Each producer shall submit a tender representing the cost of production or its willingness to supply electricity at a specified price. Tenders are evaluated and producers are compensated in accordance with their accepted tenders.
* Electrical Engineer, with many years of experience in the operation of the electrical system
