29 Aug 2019

Electricity sector holds the key for the EU’s low-carbon economy

Christian Egenhofer / Francesco Gazzoletti

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The notion of decarbonisation has changed over the years as a new consensus on long-term climate objectives emerges.[1] From being synonymous with emissions reduction in just some energy sectors, it has spread to all sections of the economy and society. Policymakers describe it as ushering in a new phase in industrialisation. aimed at underpinning the role of the EU in future technologies, fostering sustainable growth and jobs, and improving everyday life for EU citizens.

Electrification continues to be identified as a least-cost decarbonisation option. In order to be successful, this will require competitive and affordable – for both industry and citizens – low-carbon electricity at very large volumes. The EU can build upon the successes of its 2020 strategy, but the cycle from 2020 to 2030 will bring new and bigger challenges. The volumes of renewable energy needed to meet the targets are of a different magnitude. The low-carbon transition will continue to spread further beyond the electricity sector into the mobility, energy-intensive industry and gas sectors. By 2030, around 65-70% of electricity output – renewables and nuclear combined – will have zero marginal costs. This will transform the economics of the power sector.

The recently approved electricity market design provides a robust and fit-for-purpose reform of the way new electricity markets work in the context of an ever-growing share of renewable generation. The market design did not modify the way wholesale electricity prices are constituted in Europe. But, in a context of protracted overcapacity in generation, the further growth of renewable generation coupled with a stable contribution of nuclear in the day-ahead markets will further weaken the market price signal and with it, the ability to remunerate existing assets, let alone drive the investments required to meet EU climate ambitions. During its term, the new Commission will be increasingly faced with calls to provide effective signals to unlock investments, for example in the form of a newly conceived long-term price signal.

A precondition for any signal to work will be a level playing field between the growing number of market participants, implying inter alia, carbon pricing, reforming grid tariffs, aligning competition policy with decarbonisation objectives and ensuring that wholesale prices are the main component of retail prices. In addition, fostering innovation offers the opportunity to make Europe a leader in some low-carbon key technologies and thus to generate a ‘transition dividend’ in terms of growth and jobs. Finally, the spread of – direct and indirect – electrification is likely to bring to the fore the question of who pays and for what and how. With electricity being a central vector to achieve EU energy and climate goals, it is counterintuitive to tax and levy electricity irrespective of its carbon content.

[1] A new consensus is forming based on the temperature targets of the Paris Agreement, the IPCC Special Report on the 1.5C target, and its implication that virtually all greenhouse gas emissions need to be eliminated eventually in so far as possible, and any residual emissions compensated with negative emissions; i.e. a net-zero GHG, or climate-neutral economy.