"If there's one area where the European dimension makes economic sense, it's energy"

December 6, 2012 | 00:00

Interview Philip Lowe, Director-General for Energy at the European Commission

"If there's one area where the European dimension makes economic sense, it's energy"

Philip Lowe, the top civil servant in Brussels for energy, takes an upbeat view of the progress to date on the internal energy market in Europe and of the prospects for decarbonisation of the European power sector. In an interview with EER, he says the internal energy market has already led to more choice, more competition, more liquid and transparent wholesale markets, and more secure energy supplies. He is also convinced that decarbonisation targets can be met, in spite of current setbacks. "There's no reason to believe that indigenous sources of energy, i.e. renewables, could not provide competitive energy to Europe by 2020."

Philip Lowe (c) Science|Business Publishing
How far has the EU come in its pursuit of an integrated internal energy market? "Progress has been made", says the European Commission in a "Communication" on the internal energy market released in November, but it adds that "more needs to be done" to "complete" this market by 2014, the target date set by EU leaders in February 2011. The Commission acknowledges that competition in the energy sector is still quite poor in many countries, consumer involvement leaves much to be desired and investments in infrastructure are lagging. And those are merely some of the more familiar problems. In addition, many observers feel that unilateralism is on the rise. EU member states insist on following their own policies on renewable energy and nuclear power. Many are now contemplating setting up national backup capacity schemes to facilitate the integration of intermittent renewable energies, a development that would further undermine the common market.

To make matters worse, at this moment the EU's decarbonisation agenda, coming on top of the internal energy market, is also facing strong headwinds: the use of coal in power production is growing at the expense of gas, the EU's Emission Trading Scheme (ETS) has virtually ceased to function and the development of carbon capture and storage (CCS) has ground to a halt.

There are many reasons, it seems, to be skeptical about the way things are going in the European energy market. But Philip Lowe, Director-General for Energy at the European Commission, and the man who alongside EU energy commissioner Günther Oettinger is more than anyone else responsible for setting EU energy policy, refuses to give way to gloom. He says many of the problems are "transitional" or related to the financial and economic crisis in the EU. And he is convinced that in spite of current disagreements, there is an underlying "convergence of views" in Europe about the benefits of the internal energy market and the decarbonisation agenda. "If there's one area at the moment where you can say the European dimension makes economic sense, it's energy," he tells EER in an interview at his office in Brussels.

Q: How would you respond to those who say the European energy market is in bad shape with worsening tensions between national policies and Brussels?

A: People who say that seem to forget where we've come from: from markets that were truly national with nationally-oriented infrastructures, regulated prices and monopoly incumbents. Yes, realising the vision of an open, interconnected, integrated market in Europe has been a long one and is still not fully complete, but it's on its way.

That model, that vision cannot be wrong, particularly when Europe is – whatever its longer-term low-carbon objectives – increasingly dependent on imported fossil fuels. Encouraging a market where people can get the best deal from existing and new suppliers cannot be wrong, either from the point of view of security of supply or getting the most affordable prices for consumers.

We have already achieved quite a lot. We've got a very vibrant and liquid wholesale gas market across Europe now.

Europe, in a situation of energy scarcity and dependence, is increasing its dimension, making it easier to trade and invest across frontiers and giving everyone the opportunity to get the lowest price possible
Almost a third of gas is bought and sold at hubs and there is a lot of pressure on long-term contracts to reduce prices. In electricity, 17 markets are now coupled across Europe. So we have been moving towards an open, integrated, interconnected market but at the same time – and here the critics have a point – there's been a need for governments to intervene because we in Europe are committed to climate change goals. There's been a need to encourage low-carbon technologies through national support schemes and an effectively functioning Emission Trading Scheme.

At the beginning of that process it was understandable there needed to be substantial support for renewables. And you could say if renewables only represent 3% of your energy production, you don't need to worry about distortion of competition or market fragmentation. What's important is getting these technologies applied at a scale which will allow costs to come down. And they have come down for onshore wind and solar PV [photovoltaic]. There's every confidence now that in the next decade we're going to be able to use these technologies without subsidy – which means less national intervention.

Q: But aren't you sketching a very optimistic picture here? The model may be right but there are still many national decisions being made that interfere with the integrated market, and that's not just in renewable support schemes. Germany is taking unilateral decisions with its Energiewende, the UK has embarked on a reform that many call a "renationalisation" of energy policy, France still has regulated prices and little competition. Then power companies say they are not investing in Europe because there is too much policy uncertainty. The demand for gas is plunging, shale gas development has been practically halted, the ETS is not functioning and the use of coal in power generation is growing like never before.

A: First of all, I would like to say to the critics: get real! There's a recession out there and a financial crisis and there's capital rationing in the long-term institutions. They will re-engage in the energy sector when the economy recovers, however, because the energy sector is one of the most attractive ones for long-term investors. I really have my doubts about this issue of policy uncertainty. If there's a decrease in demand and you've got all these old capacities around it's inevitable that no one's investing. That's not a problem of uncertainty, that's a problem, unfortunately, of certainty that there isn't any return in it. In the global oil market there is massive investment despite huge uncertainties and risks. Corporations invest less in Europe because economic growth isn't as high here as elsewhere, not because of policy uncertainty.

On the coal-gas problem, there are many reasons why this is occurring. We're burning coal because it's cheaper than gas and the carbon price is low. Coal is now the most competitive way to produce electricity. This is not consistent of course with the longer term goal of moving to a low-carbon economy but it's the market reality out there. But environmental legislation [the Industrial Emissions Directive] will hit a significant percentage of existing coal-fired capacity in 2014-15. People will start to invest in gas-fired generation capacity again when coal-fired capacities have been phased out.
In the meantime, they are investing in renewables when they get subsidies for it. But Eurelectric [the electricity industry association in Brussels] is right to say you can't do that indefinitely and remain competitive because you're making people rely on subsidies rather than getting investments based on proper incentives.

Q: So does this mean you're feeling good about how things are going in the longer term?

A: I'm saying if Europe resolves its financial situation, if the economic situation improves, then there's no reason to believe there won't be re-engagement in the energy sector. Energy is part of the solution to economic recovery – there is a lot to do in the areas of infrastructure and efficiency in particular – but the recovery in Europe will not really take off until there is some reduction in the genuine uncertainty of how the Eurozone crisis is going to be resolved.

Q: And on the internal energy market? How far have we come there?

A: There's a dynamic of competition in the wholesale market which was not there 15 or 20 years ago. On the German-Dutch border for example, prices matched up only 11% of the time during any 24 hours over the course of any one year before electricity market coupling. After market coupling, prices converged 90% of the time and of course if they're converging because of arbitrage they're converging on the lower price.

So we can never say to industrial or residential consumers that prices are going down in absolute terms because the energy market is becoming more integrated. But we can say that Europe, in a situation of energy scarcity and dependence, is increasing its dimension, making it easier to trade and invest across frontiers and giving everyone the opportunity to get the lowest price possible.

Q: So how do you see the future of the European electricity market evolving, particularly in the context of the long-term low-carbon agenda? Should new climate and renewables targets be set for 2030?

A: You won't make a market work unless you regulate to allow people to trade and invest across it according to the same set of rules. There's nothing wrong with the accumulation of the first, second and third [energy market liberalisation] packages. You also need to agree network codes on capacity allocation, congestion, etcetera, which is what we have been doing.

Then you come up against the issue of whether you've got the infrastructure in place to support that trade and investment. Are there interconnections? You need a framework to encourage private and public investment in infrastructure. That's why we've got the new regulation on infrastructure. It makes clear what the major strategic priorities are to avoid the situation of 5 or 6 years ago where 600 projects were declared of European interest but basically they were all nationally oriented and none of the interconnections got built.

When you've got the regulatory and interconnection agendas aligned you can move to a date like the end of 2014 when you can offer the realistic prospect of people investing in a market which is integrated and interconnected.

But you're right in implicitly asking about investments in gas, nuclear and renewables – how are companies going to be persuaded to invest? We think for the post-2020 period you need to have an effectively functioning ETS, almost certainly a [greenhouse gas emission reduction] target for 2030, and some predictable framework rules on national support for renewables.

With renewables we have entered a new phase. When 20% of your energy consumption comes from renewables, you're no longer talking about a very small percentage of the market, so you need to make sure the level of subsidy in one area doesn't impact negatively on other areas. Otherwise you will undermine competition and a level playing field. We need to ensure too that new capacities in renewables are built in areas where they can make most money – build wind power capacity where the wind blows and solar where it's sunny.

In addition, you've got to work out how to deal with an electricity system which has a lot of intermittent renewable energy in it. You have to get into the business of coping with variability. Now one of the kneejerk reactions that we are seeing in countries is to say we need to finance a backup capacity mechanism, to ensure that there is backup capacity when wind and solar power do not supply enough.

If you're going to have a capacity mechanism probably the worst thing you can do is to arrange it nationally, without assessing import flows
But there are other solutions. First, if you're part of a larger network, you have more diverse weather conditions and technologies, which will likely offer you some degree of stability you wouldn't get in a smaller, national system. Second, if the system is larger you can almost certainly include countries with hydro-storage capacities, so an excess of wind and solar power can go into storage in hydroelectric schemes. A third option is to use smarter, more intelligent infrastructure to manage both supply and demand, offering incentives to your major consumers to consume when electricity is available. And then and only then you might just think about paying people to keep some reserve capacity.

Q: It seems some national governments feel differently about this, however. Some countries have already introduced a capacity mechanism, others are considering doing so.

A: Yes, Ireland has a capacity mechanism. It doesn't represent a very significant part of the market but they certainly have one. France wants to introduce one to cope with peak demand. The UK is considering the situation and there are a number of lobbies in Germany which want to do it.

Q: So what are you telling member states?

A: We've now had two or three discussions with them and we've launched a consultation paper to test the water. They're not going to argue against a solution which is more cost-effective than capacity markets and they know very well – based on US and European experience – that financing capacity is not always the best solution, because it tends to raise the barrier for new competitors.
If you finance reserve capacity in an area dominated by one supplier, it's almost certainly going to win the bid to offer that capacity and then you've increased its control over the whole market. You may guarantee 100% delivery of electricity but you may also be paying more for it because that supplier is going to increase the price. Now it may be that in certain circumstances capacity markets are the only way forward, but certainly networking, use of storage facilities and demand-side management should be tried first.

One alternative to capacity markets is actually to tender for electricity and specify in the tender "I want x% of this to be green and I want you to supply 100% of electricity at all times". Then it would be up to the suppliers to find ways of combining renewables with for example gas-fired generation. In a way if you do it the other way round, through capacity markets, you're socializing the cost. You're being technology partial.

Q: So you've been talking to them saying please don't do this?

A: Basically we're saying before you do it, look at all these other things. And if you're going to have a capacity mechanism probably the worst thing you can do is to arrange it nationally, without assessing import flows. Germany was a net exporter of electricity until the nuclear shutdown. Then it became a net importer within a few weeks. But when it came to the cold spell earlier this year, it became a net exporter again, exporting electricity to France (which relies heavily on power for heating). So there are variations in electricity flows by up to 15-20% between national markets. You could cover what you think is a system security problem simply by enlarging your interconnection zone.

Q: But the import and export flows also cause problems. For instance, the Czechs are threatening to close the border to German energy imports this winter if the load becomes too large.

A: That's a problem of unplanned loop flows where excess German electricity gets produced when the wind blows and the sun shines and it goes through Poland,

Ultimately everyone is convinced that if you interconnect you get much greater security of supply, much greater choice and you won't fall into difficulties of outages
Hungary and the Czech Republic down into Austria and back into Germany. The solution to that in the short term is some degree of financial compensation. The [German] system's operators would have to pay because by letting those flows through they're diminishing the profitability of generators in other countries. So it could be dealt with by a financial compensation mechanism, or it could be that you end up saying close the border, or you might install some phase shifters which moderate the flow. The ultimate solution is to build enough power lines inside Germany.

Q: Would better interconnections solve all our problems? Isn't every country's right to its own energy mix under the Lisbon Treaty the real issue here, which makes an integrated internal energy market impossible?

A: No, I don't think so, because member states gave away most of their discretion on energy mix when they agreed to low-carbon economy targets. Their discretion to produce energy by technologies other than renewables, nuclear and CCS is limited.

The issue of energy mix being a national prerogative is really an issue of public acceptance of different technologies. It's a government decision dictated by what the public in their country want to accept. In the UK they don't like onshore wind. In Germany they don't like CCS and they don't like nuclear, in Austria they don't like nuclear either. My impression is however, that people are not really worried about whether the electrons they use to keep the lights on are green or not green, what they're concerned about is whether there's a nuclear plant or wind turbine near their home.
Public acceptance determines what can be built but I believe ultimately everyone is convinced that if you interconnect you get much greater security of supply, much greater choice and you won't fall into difficulties of outages. Interconnection was the solution before we even came across climate change.

Q: Despite the climate agenda, our emissions are going up because we're using coal because it's cheaper than gas. Could shale gas be a way of breaking up the oil-indexed gas market? Fatih Birol, Chief Economist of the International Energy Agency, has said that European countries are missing a big opportunity by closing their doors to shale gas.

A: There's no reason for Europe – or any European country – to be immediately negative about shale gas as an indigenous source of energy. The Commission's position is to say that if these resources could be exploited under environmentally sound conditions, the discovery and exploitation of shale gas in Europe would be a very good thing. It could even be a very good thing in terms of diversification away from pipeline gas from immediate neighbours.

But for the moment there is sufficient doubt about the conditions for successful exploitation. The effects of shale gas on Europe are indirect: the diversion of gas and other commodities into Europe from the US and elsewhere. In Poland they have great hopes but the results so far seem to show that even though the reserves are there, exploiting them is not as profitable as expected. It's a lot cheaper in the US than some other places because it's extracted there at the same time as oil.

Q: So how are we going to solve the fossil fuel problem in Europe and achieve our decarbonisation goals? Coal use is growing and CO2 emissions are rising because gas is not competitive enough. The ETS, which could make gas more competitive in relation to coal, is not working and the EU has so far failed to fix it. Meanwhile, the development of carbon capture and storage (CCS) has come to a standstill. Doesn't this mean that the internal energy market is a failure?

A: I think the point is that we're in a huge transformation of the European energy economy. It's becoming more continental, more European and that was the aim of the European single market. At the same time we believe in climate change and its disastrous effects. Now we discover halfway through this process that this is going to cost us in the medium term and we start to blink, to say it's difficult, it's impossible, it's leading to more uncertainty. No, there isn't any uncertainty. We take climate change seriously but we also want to make sure our energy sources are competitive and secure.

True, we don't look as if we're going to be able to take off with CCS in the next decade in a serious way. Maybe that's not a bad thing because the costs of combining gas or coal with CCS would be in any case high. But we are making progress on the costs of renewables. There's no reason to believe that indigenous sources of energy, i.e. renewables, could not provide competitive energy to Europe by 2020. We're burning coal now because there's still a lot of legacy coal-fired capacity there. But the impact of environmental legislation already in place will mean that's going to have to be phased out. And then you have the choice of increasing the percentage of renewables even further, or turning to nuclear or gas. It is likely gas will fill that gap. It'll be very interesting for Europe to start thinking about using gas in the transport sector, as the US is doing.

Q: Does the renewables/gas combo keep us on track to our decarbonisation goals? CCS has always been a part of that picture.

A: The International Energy Agency's World Energy Outlook (WEO) in 2010 placed huge emphasis on the role of CCS and how much cheaper it would be with CCS. This year's WEO didn't mention it at all.

Q: Fatih Birol told journalists however that without CCS our chances of staying within two degrees warming are close to zero.

A: I wish he'd put that in the press release!

Q: Do you see parallels between the problems we are encountering in the internal energy market and the eurozone crisis?

No, I think it's a very different situation. The financial crisis divides countries in two ways: those who are performing better vs. those who are not and those who believe in the single currency vs. those who don't. You don't have that divide in the European energy map. Every single politician in Europe is under pressure to make sure the lights stay on and prices stay low. Every single country in the EU has virtually the same challenges in the energy area. Ten years ago the Netherlands and the UK were exporters of gas, and France had cheap electricity through nuclear. Now France has to replace its fleet and is discovering the price of energy, the UK is a net gas importer and the Netherlands will become one. Everyone is up against a big challenge. And we all agree about the need for a low-carbon economy. Therefore there is a kind of convergence of views, a consensus about solutions which is different from the financial crisis.

In fact, if there's one area at the moment where you can say the European dimension makes economic sense, it's energy. The physical interconnection and integration of markets reduces the need to find expensive national-level solutions because there's such variation in weather conditions and technologies, precisely because everyone's using a different energy mix. You're spreading the risks and you're getting the prospects of quite a stable system. Here we finally have a clear case where Europe is the cheapest solution!

 

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