A reality check for bidding zones: the energy transition needs a stable foundation

Trade associations are jointly warning against the fragmentation of the unified German electricity bidding zone: the negative impacts on the real economy are impossible to predict and outweigh any theoretical advantages. There are better ways to drive forward the energy transition, promote equal living standards and ensure high-quality employment.

THE EUROPEAN ELECTRICITY MARKET

The European electricity market is built on a stable foundation: trading within so-called electricity bidding zones. Within these uniform bidding zones, the same wholesale prices apply to all generators and consumers. A single electricity bidding zone applies to the whole of Germany. With this fundamental decision, the electricity market also contributes to ensuring good working conditions and preserving economic unity.

Other markets, such as those in the USA, where local prices are often calculated at individual grid nodes, operate differently. Here, partly based on historical experience, the focus is on the efficiency of physical dispatch. In Europe, the focus is on the liquidity of the long-term markets. These fundamentally different approaches cannot simply be combined. And so, quite rightly, the recently adopted EU electricity market reform represents a clear commitment to the zonal organisation of European electricity markets across different bidding zones and against the introduction of a nodal pricing system with centralised dispatch. With this step, the European Commission is also strengthening the long-term markets in Europe.

A key prerequisite for a functioning economy is predictability: generators must not only know what electricity will cost tomorrow, but also have a reliable expectation of the electricity price for several years ahead. This applies just as much to industrial companies as it does to domestic customers, who expect stable tariffs from their suppliers. To achieve this predictability, it is possible to trade electricity volumes at an agreed future date. This long-term trading enables sophisticated risk management, including the hedging of flexibility or credit risks arising from bilateral trade. In contrast, there is the short-term purchase of electricity on the so-called spot market. The highly liquid forward market in Germany was one of the reasons why the country weathered the 2022 energy price crisis relatively well. Companies that had not hedged their long-term exposure had to pay the highly volatile electricity prices on the spot market. In 2018, the German-Austrian electricity bidding zone was separated. Both Austria and the Scandinavian countries now secure long-term protection via stable futures trading in Germany. A functioning futures market in this country is therefore also crucial in the European context.

THE CHALLENGES ARE UNDISPUTED

Whilst generators and consumers need planning certainty and thus a stable, uniform futures market, the geographical distance between consumers and generators poses physical challenges for the grid. In Germany, the majority of renewable energy generation is concentrated in the north and east of the country, whilst the industrial centres are located in the south and west. Electricity generated decentrally and in a climate-neutral manner must therefore be transmitted over long distances. This requires a well-developed transmission grid. However, the installed capacity is not sufficient to balance supply and demand over long distances at every hour or at all times of the day. In some cases, surplus generation has to be curtailed. Consequently, power stations in other locations are brought online to maintain the balance between supply and demand. This process is known as redispatch. The EU stipulates that electricity bidding zones must not exhibit any structural bottlenecks in the long term. In 2019, Germany presented an action plan that opens up cross-border power lines more widely for trade. The Federal Republic is currently adhering to this phased action plan to achieve 70 per cent of the interconnection capacity with neighbouring countries.

THE DEBATE NEEDS A REALITY CHECK: ACTUAL OUTMIGRATION RATHER THAN INFLOW

It is suggested that that a split in the German electricity bidding zone would be accompanied by further industrial firms setting up operations in zones with, supposedly, lower electricity prices. At the same time, it is emphasised that, over the course of a year, price differences between the newly created bidding zones would not be very significant. This claim is misleading in two respects: electricity prices in Germany already represent a locational disadvantage by international standards. A division of the electricity bidding zone would cause electricity prices to rise, particularly in the industrially strong south and west of Germany. However, this would not lead industrial companies to decide on a new location or to relocate within Germany. Most existing production sites, with their networks of various companies and established value chains, cannot be relocated. Price differences within Germany exacerbate the overall locational disadvantage, not least because, from a business perspective, the regulatory risk of further division of electricity bidding zones is growing. This uncertainty threatens to result in a massive loss of industrial value creation and good employment conditions in Germany.

A PARADOXICAL SITUATION FOR RENEWABLE ENERGY

Added to this are exacerbating negative effects on renewable energy producers: On sunny or windy days with a surplus of green electricity, electricity prices in zones with a high share of renewable energy would fall drastically and sharply. What might initially appear to be an advantage for consumers would, however, pose a problem: On the one hand, the market values of renewable energy would be significantly reduced, which would lead to a greater need for financial hedging. On the other hand, electricity prices would rise significantly in areas with lower volumes of renewable energy. This, too, would be extremely detrimental to consumers.

Within a smaller electricity bidding zone, there would be much stronger reactions to additional generators or consumers. This increases uncertainty regarding expected revenues and costs for investors. The result: urgently needed investments would be scaled back, and the expansion of renewables would be hampered.

Fundamentally, there are also pragmatic arguments against dividing the market into bidding zones: implementation would be highly complex. Dividing the market into several bidding zones cannot be done at the flick of a switch, but would take several years. In the process, various important questions would have to be answered and the markets fundamentally reorganised. For market participants such as energy generators or industry, this would initially result in one thing above all: considerable uncertainty at a time when transformation is urgently needed.

Had a division of electricity bidding zones been implemented five years ago, it would have followed the course of the River Main. The division of electricity bidding zones currently under consideration, by contrast, is planned to lie significantly further north. Furthermore, a division into two zones is not the only option; a division into up to five or more bidding zones is also conceivable. As the expansion of renewable energies and grids continues to gather momentum, existing grid bottlenecks will ultimately be resolved. At the same time, further bottlenecks may emerge. This means that any bidding zone demarcation once implemented will always be called into question. Based on grid development plans and the expansion of renewable energy in the new federal states, it may be necessary to redraw the boundaries in a further five years’ time. This undermines the reliability of investment.

AVOIDING MARKET POWER CONCENTRATION

Proponents of dividing the electricity bidding zone argue that this would balance supply and demand at a regional level. However, this seemingly elegant solution would have significant negative effects on the national economy, the energy transition and all market participants, including consumers: If a bidding zone is split, trading volume falls and, with it, the number of market participants. A dominant market position held by a small number of players becomes more likely, and consumers are exposed to greater uncertainty.

TACKLING CHALLENGES IN THE EXISTING SYSTEM

It is true that the current challenges in the grid must be addressed. However, it would be too short-sighted to narrow the range of possible solutions solely to the option of splitting the electricity bidding zone. If we now risk the expansion of renewables collapsing, with industry seeing no future and postponing urgent investments or even leaving the country, we will face far greater economic and social challenges.

Focusing the discussion solely on electricity prices in the short-term spot market falls short. The range of possible solutions is significantly broader and encompasses the entire value chain. For example, local incentives outside the spot market can contribute to the solution. The challenges facing the grid can only be solved sustainably through physical expansion: we need more storage, more electrolysis, more direct supply to commercial and industrial SMEs, and better utilisation of the existing grid infrastructure. These solutions are more complex than simply drawing a line on a map – a move that carries incalculable economic risks – but they fundamentally address the challenges.

Redispatch costs money; grid expansion costs money. But ultimately, we will create a liquid electricity market in Germany that can serve as a model for the energy transition – in conjunction with the various renewable technologies and the diverse regional conditions across Germany. With a sound regulatory framework, the real economy can mobilise private capital to continue the energy transition ambitiously, whilst simultaneously creating good jobs and thus generating greater added value in Germany. For this reason, it is worth tackling these complex tasks.