Fit-for-55
In July 2021, the European Commission published the Fit-for-55 policy package, a comprehensive collection of both new policies and revisions to existing legislation that sets the EU on the pathway to reducing carbon emissions by 55% by 2030 and achieving carbon neutrality by 2050. The Fit-for-55 package encompasses a broad suite of legislative initiatives impacting all parts of the economy and affects the entire value chain, but perhaps most directly the energy sector.
To align energy policy with the ambitions set out in the EU Green Deal and Climate Law, the Fit-for-55 package mandates a significant increase in the uptake of renewable energy.
Setting the legislative framework that makes this possible, the Commission proposed a revision of the 2018 Renewable Energy Directive (RED II)1. This Directive establishes a common framework for the recognition, production and promotion of energy from renewable sources in the EU, and has been updated to increase the overall ambition of the EU to reach a target of 40% renewable energy by 2030. The primary technologies which the Commission is aiming to promote include wind, solar, hydrogen and to a lesser extent biomass.
RePowerEU
While the uptake of renewable energy has been a climate imperative during this Commission’s mandate, since the onset of the war in Ukraine, and the weaponisation of Russian fossil fuels, the European Union has come to appreciate another aspect of the move to renewable energy: energy independence. In reaction to the war, the EU has adopted the ‘RePowerEU’ plan, under which targets for the deployment of renewables have increased and permitting rules, a major delaying factor towards greater renewable energy roll-out, have been addressed.
In total, under RePowerEU, renewable energy generation capacities are currently set at 1236 GW by 2030. This includes 320 GW of solar photovoltaic that should be newly installed by 2025, increasing to 600 GW by 2030. Should these 2030 targets be met, solar would be the EU’s single largest renewable energy source by the end of this decade. The deployment of offshore wind energy is likewise at the core of delivering on the EU decarbonisation targets. In order to achieve its ambitions, the European Union also adopted an offshore wind strategy under which 60GW of offshore wind by 2030 and 300GW by 2050.
The combination of these two forms of variable renewable energy would mean smaller bills and smaller environmental impacts for all consumers - businesses and private individuals alike. However, the rapid deployment of wind and solar power needed is currently hampered by local planning and permitting delays. As a result, under RePowerEU, the EU has proposed a wholesale reform to the planning and permitting process2. In the short term, the Council has adopted a regulation which would allow renewable projects like wind and solar to avoid some of the more onerous environmental impact assessments3. This would apply for the calendar year of 2023, with a view to extending the regulation thereafter if needed. On a more long-term horizon, however, these rules will be integrated within the Renewable Energy Directive and will include the designation of ‘renewables go-to areas’, in which they are exempted from certain environmental impact assessment requirements.
If the European Union can deliver on its ambitions of 1236 GW of renewable energy by 2030, and many multiples of that by 2050, the EU will have more energy than our current economy can consume. This is at the core of the business proposition of a (green) ‘hydrogen economy’, wherein the excess power produced by renewable energy installations would be used to produce hydrogen for applications such as natural gas and coal displacement in energy-intensive industries, energy storage, and transport.
With ongoing concerns in Europe regarding the impacts that short term energy prices are having on the international perception of the bloc as a ‘good place to do business’, the promise of an abundance of renewable energy - both in the form of electricity and hydrogen - makes the bloc a possible location for a future green industrial hub.
The 2023 Renewable Energy Directive (RED III) is currently being finalised between the ‘Trilogue’ negotiators - the Commission, Council, and Parliament - with a view to adopting a finalised proposal in the coming months. Once the legislation is enacted in Brussels, this will fire the starting gun on a two-year transposition deadline for Member States to set out a roadmap of how the increased ambitions can be achieved.
Electricity Market Reform
While the promise of abundant renewable energy bodes well for a cheap, green hub for industry at present, in the short-term, Europe is battling an energy supply crisis as a result of its dependencies on third countries for the delivery of important energy carriers, such as natural gas.
This has spill-over effects on the real economy, given the relationship between supply, demand and price, and has led policymakers in Brussels to look at reforming the EU’s electricity market to ‘decouple’ the price of natural gas and electricity. Electricity market reform is set to become one of the most hotly debated topics in Brussels and throughout Europe this year. The reform could have major implications for European businesses through either increased or decreased electricity bills depending on how well the reform is designed. The reform could also have implications for long-term renewable energy targets should the revisions fail to incentivise renewable development sufficiently through market pricing.
Discussions on the reform of the market began in earnest in mid 2021, with certain Member States voicing concerns regarding the spiralling cost of electricity on the market as a result of the price of gas. The initial position of the Commission had been that there is no need for a reform of the wholesale electricity market, as it already protects consumers through efficiency gains, and that the ongoing electricity price crisis was the result of a supply shortage of natural gas.
However, many Member States (particularly the Iberian Peninsula) rejected this position, and have since been lobbying for structural market reforms. A central point from a political perspective is the scale of electricity trading which is conducted in the short term markets (day-ahead) and the reliance on the ‘pay-as-clear’ model or ‘merit order pricing’ in these markets. This pricing mechanism links the price of the most expensive energy commodity (often gas) to that of lower-cost technologies such as wind and solar. The rationale is that ‘clearing price’ will incentivise market efficiency, with high-priced commodities like gas making only small profits, while low-cost generation methodologies like wind and solar make significant profits.
To address this issue in the short term, the Commission enacted a regulation setting a price cap on ‘inframarginal generators’ (like wind and solar) of €180 per MW/ hr. The excess from the price cap can then be used by Member States for either direct payment to consumers, or to invest in renewable rollouts, energy efficiency improvements, or other policies aimed at alleviating pressure on consumers. Member States, however, were also given scope to add technology specific price caps and taxes in their respective countries, creating a patchwork of regulatory approaches across the bloc, and leading to significant uncertainty for investors.
In light of the ongoing energy security and thus price crisis, the Commission is now looking at more structural reforms to better protect consumers from excessive price volatility, to support their access to secure energy from clean sources, and to make the market more resilient. Principally, the Commission is aiming to:
- Make electricity bills less dependent on short-term fossil fuel prices and boost the deployment of renewables.
- Improve market functioning to ensure security of supply, and fully utilise alternatives to gas, such as storage and demand response.
- Enhance consumer protection and empowerment.
- Improve market transparency, surveillance and integrity.
In light of these reforms, European electricity markets could undergo some of the most significant reforms since the introduction of the Clean Energy Package in 2018 and will possibly undergo the most transformation since the beginning of market liberalisation through the first energy package in 1996. Part of this shift would see some degree of a move away from the short-term markets and towards electricity purchased on long term contracts. Renewable Power Purchase Agreements (PPAs) which involve a direct contractual relationship between a renewable energy provider and an energy consumer, as well as Contracts for Difference (CfDs), whereby a long-term price is agreed upon between a generator and consumer, with a financial contract supporting the agreement which would shield the consumer from price fluctuations.
The proposal of the EU’s electricity price cap and broader reform of the market, however, is already having significant implications for renewable energy developers given the level of uncertainty it introduces into their investment models. Some of Europe’s leading renewable energy developers are now instead focussing on development in the US market, given the new tax credits announced by the Biden administration through the Inflation Reduction Act.
The European Commission closed a public consultation on the wholesale electricity market reform on 13 February and is aiming to publish a legislative proposal on 14 March 2022. Whether the EU can deliver on its energy decarbonisation objectives, while also protecting EU businesses and consumers from volatile prices, will depend on how well these reforms are designed.