Usefulness of the article: This note focuses on the European electricity interconnection projects currently under way ( ). It presents the context for these interconnections, as well as the challenges associated with the widespread deployment of renewable energy sources and their impact on market balance. A number of solutions to these challenges based on economic theory are discussed.
Summary:
- Electricity interconnections enable electricity to be traded between countries. They are an alternative source of supply to flexible power plants capable of producing on demand without any technical constraints.
- The integrated European electricity market is booming, with 97 projects currently underway.
- The low marginal costs of random energy sources, such as photovoltaic and wind power, resulting from public support mechanisms for these sources, are driving down the wholesale price of electricity and pushing flexible power plants out of the market.
- There is a low degree of diversification of intermittent renewable production sources at the national level, compounded by a lack of storage solutions. It is therefore important to maintain flexible and controllable production.
- Solutions for better remuneration of these flexible production sources are being explored (separation of wholesale price auctions according to the type of power plant, integration of storage and destocking costs into the wholesale price, etc.).
An electrical interconnection is a structure connecting international electrical grids and enabling electricity to be exchanged between regions. This makes it possible to diversify electricity supply sources by drawing on the production and transmission capacities of a neighboring region. If electricity production between geographical areas is uncorrelated, i.e., if there is complementarity between regions, interconnections can compensate for sudden failures in one of the regions. As part of the European Green Deal, whichaims to increase the share of renewable energy toat least 32% by 2030, they help to increase the resilience of the sector and reduce carbon emissions in the absence of storage capacity. Indeed, we are seeing a significant increase in the share of renewable energy sources characterized by their intermittency.
Figure 1: Evolution of renewable energy production in the European Union 1990-2019
Source: IEA (2019)
The European Union (EU) has set a target of 10% interconnection between countries by 2020 and 15% by 2030. This means that by 2030, each member state must be able to export 15% of its production capacity to neighboring countries. The expansion of the European electricity grid comes with many challenges in terms of coordination between countries in order to benefit from a more competitive market while reducing carbon emissions.
1. History of Interconnections
The first major interconnection projects in Europe emerged in the aftermath of World War II in 1951 with the creation of the Union for the Coordination of Production and Transport of Electricity (UCPTE). Initially, cross-border exchanges took place between vertically integrated monopolies through export contracts and mutual assistance agreements. Exchange tariffs and capacity were therefore set by bilateral monopolies. In the early 1990s, Norway, Sweden, and the United Kingdom were the first European countries to have a liberalized electricity market. Trade between Norway, Sweden, and later Finland took place through an energy exchange: NordPool (Pollitt, 2019). It was not until 1996, with the first wave of liberalization of the electricity sector, that electricity production and supply activities were opened up to competition. However, the networks remain local monopolies due to high fixed costs, but the role of interconnections is growing as they support the integrated market.
With regard to network regulation, two bodies were created: the Agency for the Cooperation of Energy Regulators (ACER) and the European Network of Transmission System Operators for Electricity (ENTSO-E). Their objective is to ensure third-party access to the networks. Indeed, the electricity network is considered to be essential infrastructure.
In France, the Energy Regulatory Commission (CRE) has introduced the Public Electricity Network Usage Tariff (TURPE) to finance network infrastructure. The TURPE and the interconnection revenues collected at each border cover the costs associated with interconnections.
Today, the European electricity network covers most European countries and is organized into five synchronous areas: continental Europe, the Nordic region, the Baltic region, Great Britain, and Ireland. Each area has its own frequency, but they are interconnected by high-voltage direct current stations.
France has historically been a net exporter of electricity. It is interconnected with six countries (Great Britain, Belgium, Germany, Switzerland, Italy, and Spain), but capacities differ between countries. For example, export capacities are more developed with Switzerland, Italy, Spain, and the United Kingdom, while imports are more significant from Central and Western Europe (CWE), i.e., Belgium and Germany.
Figure 2: Electricity trade in 2017
Source: CRE (2019)
2. Interconnection projects in progress
In 2018, ENTSO-E adopted a 10-year network development plan (TYNDP). Within this framework, there are currently 97 interconnection projects, of which 21 are under construction, 27 are under negotiation, 12 are planned, and 37 are under consideration (ENTSO-E, 2020). Of these projects, 9, 19, 3, and 2 are classified as projects of common interest (PCIs) as defined by European Commission Regulation No. 347/2013. PIC status allows them to benefit from a fast-track procedure for obtaining permits, as well as financing mechanisms. For example, they can access European financial aid. They can also establish an investment cost-sharing agreement with regulators (CRE, 2019).
Interconnections were initially deployed to increase network resilience (ENTSO-E, 2018). Today, they also meet two new needs: increasing socio-economic well-being and integrating renewable energies (RE) into the electricity mix in order to reduce carbon emissions.
In France, 16 interconnection projects are underway, including three under construction. Fifteen of these projects will strengthen existing interconnections, either by modernizing infrastructure, reducing congestion on an existing line, or improving the integration of RE.
Figure 3: Interconnection projects in France (ENTSO-E, 2020)
A new link between France and Ireland is expected to be completed in 2025: the Celtic Interconnector. This new interconnection aims to exploit the complementarities between the two electricity mixes. Ireland is the second largest producer of wind energy among the members of the International Energy Agency, while France has the largest nuclear production capacity in Europe. More broadly, the Celtic Interconnector should enable Ireland to benefit from the more reliable continental network and the integrated European market in the context of Brexit.
Two other projects classified as being of common interest for 2020-2021, which are particularly interesting for better integration of the European market, are Nordlink and NorthSea Link. The first is between Norway and Germany; the second between Norway and the United Kingdom. Norway has enormous hydroelectric capacity, as well as pumped storage power plants that can store energy. Germany and the United Kingdom have high levels of intermittent wind power generation. Pumped storage power plants can absorb surplus renewable energy that would otherwise be lost and provide electricity when wind power generation is low.
3. Challenges of interconnections
In Europe, for geographical and historical reasons, each country has its own unique electricity mix. For example, in France in 2020, nuclear power accounted for 67.21% of total energy production, followed by hydroelectricity (11.74%), wind power (7.42%), and gas (6.48%). In Germany, there is significant wind power production (23.71%), which is supplemented by coal (23.66%). Poland relies mainly on coal (69.84%).
In geographical areas where there is a high deployment of intermittent renewable energy sources, flexible power plants (such as thermal power plants and hydroelectric plants with large reservoirs) are designed to ensure the security of the electricity systems.
Electricity interconnections can complement or even replace flexible power plants to ensure system resilience when the share of renewable sources in the electricity mix is high (Yang, 2020). Provided there is coordination between countries in the deployment of their production sources, demand can be offset by flexible power plants in neighboring regions or by renewable energy sources when the correlation between them is imperfect. The more renewable sources are correlated, i.e., the more often they are exposed to the same weather conditions, the more unused or even eliminated capacity we will have when weather conditions are favorable. This reduces the potential benefits of interconnections in a context of high renewable energy deployment.
Currently, the instrument that enables the coordination of different power plants is the wholesale price. This wholesale price is formed within each local market using the conceptof merit order, which calls on power plants based on the marginal cost of production. The wholesale price is therefore a signal of the resources available within each country; it does not take into account network charges or taxes. Since electricity is a homogeneous commodity, interconnections benefit the most cost-effective technologies. The coupling of electricity markets therefore directs electricity flows from regions with low wholesale prices to regions where prices are higher.
While interconnections can help compensate for sudden failures in a geographical area, they can also force flexible power plants out of the market.
Numerous financial support mechanisms such as feed-in tariffs, green certificates, and priority access to the grid (Bahar & Sauvage, 2013) have been put in place to develop renewable energy. This has led to a drop in wholesale prices, but electricity demand has remained unchanged. However, this has not been the case for the retail price paid by consumers, which has instead increased due to taxes to finance renewable energies. In order to maintain a certain level of security of supply, flexible power plants must be kept running, which entails costs that are passed on to consumers in the form of renewable energy charges.
Markets with a strong presence of intermittent renewable energies can therefore experience periods of very low or even negative wholesale prices (Germany 2009). This can be exacerbated by the social cost of carbon( SCC). Yang (2020) considers that an interconnection between a region with a predominantly renewable electricity mix and another region with a predominantly fossil fuel mix can increase (or reduce) carbon emissions when the SCC is low (or high). Access to low-cost fossil fuel-based electricity has two effects: a reverse technology effect and a scale effect. The first limits the deployment of renewable energy sources, as fossil fuels are used more extensively. The second leads to an increase in electricity demand. These two effects exacerbate emissions levels.
Several solutions exist to ensure better functioning of the wholesale market. In order to benefit from the full potential of interconnections in terms of system resilience while integrating renewable energy to reduce carbon emissions, these solutions need to be coordinated at the regional level.
A first solution proposed by Percebois and Pommeret (2019) is to take into account the costs of storing and releasing energy associated with intermittent renewable energy sources. These costs would be taken into account as externalities in the same way that fossil fuels include carbon emissions in their costs. Beyond CCS, other instruments for integrating the externalities associated with emissions can be considered, such as carbon permits.
Another possibility is to split wholesale auctions into two: one for flexible power plants based on marginal cost and another for intermittent production based on average cost. Marginal cost represents the cost of producing an additional watt, while average cost is the unit cost of production. Renewable energies would be given priority when their average production cost is lower than the marginal cost of flexible power plants. This seems possible with a high Pigouvian tax at the CSC level, which would also allow for a competitive decentralized market.
Finally, Hildmann, Ulbig, and Andersson (2013) propose increasing the volume traded on electricity exchanges while eliminating support mechanisms for renewable energy sources. Currently in France, it is possible to purchase electricity on exchanges such as EPEX Spot (for intraday and day-ahead trading) or EEX Power Derivative (for futures trading) or through bilateral OTC (Over-the-Counter Trading) contracts. These measures would allow for a functional market despite the widespread deployment of renewable energy sources. However, an increase in the volume traded on the spot market could lead to difficulties similar to those experienced during the California energy crisis.
Conclusion
In Europe, a significant number of projects are underway to achieve the target of 15% interconnection between countries by 2030. These projects reinforce existing lines to reduce congestion and exploit complementarities between countries in the context of renewable energy deployment.
Without revisiting the current organization of the wholesale market and therefore of electricity exchanges between countries, the costs associated with interconnections may outweigh the benefits. Economic studies propose numerous solutions for reassessing the real cost of renewable energy while integrating the externalities associated with pollution. However, in the context of the expansion of the integrated European market, these measures must be uniform and coordinated at the regional level.
References
Bahar, H. and J. Sauvage (2013), « Cross-Border Trade in Electricity and the Development of Renewables-Based Electric Power: Lessons from Europe, » OECD Working Papers on Trade and Environment, No. 2013/02, OECD Publishing, Paris, https://doi.org/10.1787/5k4869cdwnzr-en.
European Commission. (2013). Regulation No. 347/2013.
Energy Regulatory Commission. (2019). Interconnections.
Dambrine, F. (2019). Microeconomic analysis of the integration of intermittent renewable electricity sources into an electricity production system. Annales des Mines – Responsibility and Environment, 1(1), 7-14. https://doi.org/10.3917/re1.093.0007
ENTSO-E. (2020). TYNDP 2020 Projects Sheets. (Data).
M. Hildmann, A. Ulbig and G. Andersson, « Revisiting the merit-order effect of renewable energy sources, » 2015 IEEE Power & Energy Society General Meeting, 2015, pp. 1-1, doi: 10.1109/PESGM.2015.7286477.
Our World in Data. (2020). France: Energy Country Profile. https://ourworldindata.org/energy/country/france
Percebois, Jacques & Pommeret, Stanislas, 2019. « Storage cost induced by a large substitution of nuclear by intermittent renewable energies: The French case, » Energy Policy, Elsevier, vol. 135(C).
Pollitt, M.G. The European Single Market in Electricity: An Economic Assessment. Rev Ind Organ 55, 63–87 (2019). https://doi.org/10.1007/s11151-019-09682-w
Yuting, Y. (2020). Electricity Interconnection with Intermittent Renewables, TSE Working Paper, No. 20-1075.
[i]Sources of production whose output cannot be controlled and which depend on natural elements.
[ii]Infrastructure that is extremely difficult to replicate due to physical, geographical, or economic constraints. Denying access to this infrastructure is considered an abuse of a dominant position.
[iii]Power plants are brought online based on their variable production costs.
[iv] This refers to the electrical current used by consumers to power equipment.
[v]The social cost of carbon (SCC) measures the present value in monetary terms of the damage caused by the emission of an additional ton of carbon.
[vi] When the electricity market in California was liberalized, electricity distributors were obliged to purchase energy on the exchange. It was no longer possible to negotiate long-term contracts with producers.
This led to illegal price inflation on the exchange, driven by the Enron company. Electricity production was reduced, leading to an energy shortage: the California energy crisis.
