Filenews 29 June 2025 - by Andreas Poulikkas
The implementation of the European Target Model in the Cypriot electricity market is one of the most important steps for the harmonization of our country with European energy policies.
Despite the expected benefits, Cyprus faces particular challenges, due to the small size of the market, energy isolation and the absence of interconnection with the European grid.
The lack of electricity interconnection with the EU's internal electricity market and storage units, combined with dependence on imported fuels, creates conditions conducive to the abuse of market power and the artificial inflating of electricity prices.
Recent discussions, based on the results of the dry-run, have focused on the need to decouple renewable energy prices from conventional unit price fluctuations in order to avoid price containment weaknesses and enhance transparency and stability in the Cyprus electricity market.
Two reaction mechanisms
To address these challenges, two main mechanisms, which have been tested in mature electricity markets, can provide an effective solution:
(a) the ex-ante market power mitigation mechanism, and
(b) the price shock absorber.
These mechanisms are a strategic choice that can transform the functioning of the Cypriot electricity market, offering a solution to the problem, allowing the decoupling of renewable energy prices from the high prices of conventional units during periods of high conventional fuel prices and consequently energy crisis.
However, we must keep in mind that there are no magic solutions. No matter how much we want to simplify the market rules governing the electricity market, the result will always be complex.
The ex-ante market power reduction mechanism is a standard practice in all regulated regions of the United States, such as PJM, NYISO, CAISO and ERCOT.
The mechanism is also implemented in many other countries worldwide, with the aim of preventing abuse of market power before it occurs. Its basic principle is based on the use of default energy bids (DEBs), which are determined based on the short-term marginal costs of the production units.
When a bid exceeds or falls short of the default threshold beyond a certain tolerance percentage, an automated review and correction process is triggered.
The price shock smoothing mechanism was developed during the 2022 energy crisis, when high gas prices led to dramatic increases in electricity prices. The mechanism continuously monitors the accumulated inframarginal rent of a basket of renewable energy sources. When this accumulated yield reaches a predetermined multiple (usually 2-3 times) of the levelized fixed cost of these technologies in a given period of time, the mechanism is automatically activated.
A temporary restriction on the ability of conventional production units to set the wholesale clearing prices of the market is then introduced, through the application of a fixed maximum price.
The innovation of the mechanism lies in its ability to temporarily decouple electricity prices from extremely high conventional fuel prices, while maintaining the basic functioning of the market. Renewables receive the capped price, while conventional units needed to meet demand are compensated for their additional fuel costs through a separate cost recovery mechanism.
Bilateral contracts
The above mechanisms apply exclusively to the day-ahead stock market and do not affect futures contracts or bilateral agreements. This selective application ensures that long-term investment decisions and the growth of the futures market are not hampered.
The futures market works independently, as long-term contracts have locked prices, which do not depend on stock market fluctuations. This separation is fundamental to maintaining long-term investment incentives and developing effective risk management tools.
Futures contracts, including bilateral energy purchase agreements, continue to operate on the basis of their agreed prices, regardless of market interventions. This ensures that renewable producers can secure stable revenues through long-term contracts, while benefiting from improved pricing on the stock market.
Changes in software and law
The integration of the above mechanisms into the electricity market management software that will be used in the Cypriot market requires technical adjustments, but it is fully feasible. The software has the flexibility to integrate complex pricing structures and constraints, is designed to maximize overall social well-being, and can support differentiated offerings by technology.
The modifications will include the creation of a database for the default energy offers of each unit, the development of algorithms for automatic checking and correction of bids, as well as the monitoring and activation of the tariff vibration smoothing mechanism.
The implementation of the above mechanisms in Cyprus is expected to bring significant economic benefits for the national economy.
Reducing electricity costs will improve the competitiveness of Cypriot businesses and reduce the cost of living for households. This is particularly important for an economy facing challenges due to energy isolation and dependence on imported fuels.
Stabilizing energy prices through reduced dependence on fossil fuel fluctuations will create a more predictable business environment, boosting investment activity and supporting the island's long-term economic growth.
The introduction of the mechanisms requires amendments to the existing legislative framework of the Cypriot electricity market. The necessary changes include the amendment of the Electricity Market Rules approved by CERA and the incorporation of new provisions for the calculation and application of the default energy offers.
The regulatory framework should ensure transparency in the functioning of the mechanisms and protect the rights of all market participants.
Harmonization with European legislation, especially with Directive 2019/944 on the internal electricity market, is crucial for the legality and acceptance of the mechanisms. Experience from other European countries shows that such mechanisms can be implemented within the existing European framework, without the need for specific approval.
The successful implementation of the mechanisms requires a concerted effort by all stakeholders. The phased implementation with an initial pilot period will allow technical issues to be identified and resolved before full activation. Continuous monitoring and evaluation of the results will ensure that the mechanisms work effectively and adapt to evolving market conditions.
* Professor of Energy Systems
Frederick University
