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Many Sellers and a Single Buyer
Can we have a full liberalization of the electricity market, while the wholesale market is still not fully reformed?
AUTHOR: Atanas Georgiev

Talking about liberalization, we usually direct our attention toward the ability of end consumers to switch their suppliers. As discussed during the last ten years, households and small businesses are the last customer segment that finally got its right (not only in legal, but also in technical terms) to choose an alternative energy trader. However, we are frequently forgetting the “Elephant in the room” – the wholesale market, which is not developing quickly enough.

The main prerequisite for successful electricity market liberalization will be the reform of the wholesale market. To get a positive result, the cross-subsiding should be eliminated because of its detrimental effects for the market. And if there is only one main supplier at the wholesale level, no matter how many sellers compete at the retail level, there could not be real change.

Many sellers, but one single buyer

The Bulgarian electricity market has been developing step by step since 2004. The historical model is based on a “single buyer” (NEK), who purchases electricity from producers and then sells it to large industrial entities and to end suppliers, who then in turn sell it to smaller and smaller customers. Is it possible to have many “sellers” (more and more electricity traders have been licensed and want to operate in Bulgaria), while there is only one official “buyer” of so much electricity?

The first stage has been the “opening” of the market for the largest industrial consumers – since 2004, and then lowering the threshold for smaller and smaller consumers. The quotas for buying electricity from power plants have been diminished gradually until 2016 and now we see that NEK is buying less (but also selling even less) electricity at regulated prices.

The long-term contracts of NEK with the lignite power plants in the “Maritsa East” basin, as well as the obligation to purchase electricity from RES and cogeneration over 5 MW, have been filling NEK’s portfolio (in addition to its own production from HPPs) in the last 10 years. Also, end suppliers are obliged to purchase RES and cogeneration electricity from all producers with capacity under 5 MW.

However, these quantities did not diminish accordingly with the diminished share of NEK and end suppliers during the shrinking of the regulated segment. In the same time, the Energy and Water Regulatory Commission (EWRC) is trying to cushion the effects of NEK’s high costs for purchasing this electricity by reserving some quotas for “cheaper” electricity, produced by NEK’s hydropower plants, by NPP Kozloduy, and by TPP Maritsa East 2. This approach currently leads to an obligation of NEK to buy at regulated prices about 1.46 times more electricity than it is supposed to sell at regulated prices for the period July 1, 2016 to June 30, 2017.

Regulated… Market?

The existence of quotas for power plants and their obligation to sell firm quantities to NEK at firm prices is affecting not only customers in the regulated segment of the market, but also everyone, who wants to buy electricity in an alternative way. As previously discussed in our publications, the low regulated prices for the power plants (below their stated costs) are a form of cross-subsidy, which eventually leads to higher offer prices in the free segment of the market. Moreover, the obligations of NEK mean, that it should purchase more than 56% of the electricity, needed in Bulgaria, in the aforementioned period. If we add to this share the obligatory quantities purchased by end suppliers, the available electricity for trade becomes even less. Meanwhile, the forecast of the EWRC is that the share of the regulated segment would be only 42% in the same period.

So, is it possible to have a dominating “free” market, while most of the quantities are regulated under the historical “single buyer” terms? Thus we get to the oxymoron, called “Regulated Market” – supply and demand are not balanced properly, because large part of the quantities sold are still following the historical regulated pattern.

The power exchange and its role

The Independent Bulgarian Energy Exchange (IBEX) started operation on January 19, 2016 with deals for the next day. The Day-Ahead Market (DAM) is fully operational and accommodated between 4-10% of the quantities in the domestic market (depending on whether you include only Bulgarian consumption or exports as well). It shows good correlation to regional power exchanges in terms of prices and market share. However, this would not be enough for ensuring the quantities, needed by all alternative traders.

In other more developed markets, the DAM is usually responsible for a small share of the trade, as no one wants to put all their eggs in one basket, especially in the last moment. So, IBEX has announced that in the second half of 2016 it would open a bilateral contract platform, which will make it easier for power plants, traders, and large consumers to contract for periods of 3, 6, 12, or more months ahead. Positive as it is, however, this would not solve the problem with regulated quotas and prices. The new platform would, eventually, only make the bilateral trade more transparent, liquid, and open than before.

The solution – Contracts for Difference?

A solution, mentioned by both the Bulgarian government and their consultant The World Bank, includes the so-called “Contracts for Difference” (CfD), which may truly open the wholesale market in the country. Explained in short, the obligations of NEK and end suppliers to purchase electricity according to long-term contracts should be replaced by a free trade mechanism (everyone selling as they please – on the IBEX or via bilateral contracts) with an obligation of the state to cover the differences between the initial contracted prices and the real prices after the trade.

This is not a cost solution – in the ideal case, costs would be the same for end consumers. It is mainly a market liquidity solution, because the “single buyer” model will be finally replaced by a model with many buyers and many sellers: what we usually call a “market”. The CfD model is not perfect, as we currently see in Central and Western Europe, but it could serve us well until the long-term contracts are expired.

The new market model is expected soon, but there are many issues, that are still not quite clear:

  • Do we have a robust mechanism for compensating the “differences” – through the state fund for security of energy supply or otherwise?
  • Are we sure, that all producers would agree to the new model… and have we asked them all?
  • Is this a new model for “state aid” and should we coordinate it with the European Commission?
  • Do we have an action plan for the implementation of the change – with a clear time-frame and associated costs?

If there are many “No” answers to the questions above, we have a problem. So let’s find the solution together and finally open the market.

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20.03.2022  Teodor Bobochikov, Managing Partner, V-Ridium
Energy Transformation – Trends and drivers
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