Introduction to Energy Markets. Energy Market Integration and Regulation: European Experience

Lecture content:

1. Introduction: what are energy markets
2. Forms of organization of energy markets
3. Specifics and stages of development of energy markets
   3.1. Electricity market
   3.2. Natural gas market
   3.3. International integration
   3.4. Other energy markets in Ukraine
4. The role of the national regulator in the functioning of energy markets
5. European institutions and regulatory mechanisms
6. Active links (legal acts, standards, resources)
7. Glossary
8. Questions for self-testing

1. Introduction: What are energy markets?

Energy markets are systems of relations between participants that arise for the purpose of buying and selling, transmitting, distributing and consuming energy, primarily electricity and gas. They include:

• production,
• distribution,
• consumption of energy resources,
• trading in them.

This is a complex set of economic relations, mechanisms and institutions, including institutions of legal regulation.

From the point of view of economic theory, the functioning of markets is based on the category of balancing supply and demand. There is a consensus among economists: the most effective mechanism for the development of economic sectors, including energy, is market relations.

In the structure of the energy market, separate segments can be distinguished. The most complex and specific is the electricity market.

In Ukraine, its functioning is determined by the laws:

• “On the Electricity Market”,
• “On the Natural Gas Market”.

In addition, there are markets for:

• petroleum products,
• coal,
• energy wood,
• SRF (solid recovered fuel),
• RDF (refuse-derived fuel).

2. Forms of organization of energy markets

Energy markets can be classified according to various criteria:

1. By the form of trade organization:

• Spot market — an open financial market where assets (for example, electricity) are traded instantly, in real time.
• Bilateral contract market — agreements directly between a seller and a buyer.
• Futures market — trading in contracts that oblige to buy or sell an asset in the future at a predetermined price.
• Forward market — concluding contracts with a fixed future price (forward rate quotations).

2. Capacity market:

In Europe, there are already some developments in the development of this segment. It is not yet used in Ukraine, however, discussions are ongoing in the electricity sector about the need for its implementation, in particular, the introduction of a capacity fee.

3. By level of liberalization:

• Regulated market (prices and rules are set by the state).
• Liberalized competitive market (prices and conditions are determined by competition).

4. By territorial basis:

• Regional.
• National.
• European Union market.
• World.

5. By level of centralization:

• Wholesale market (contracts between large manufacturers, suppliers and traders).
• Retail market (supply to end consumers).

3. Specificity and stages of development of energy markets

3.1. Electricity market

The electricity market is the most specific in terms of regulation, since this product has unique properties: it is produced and consumed simultaneously, which creates additional challenges for the organization of efficient markets.

All energy markets are characterized by a high level of monopolization.

Main stages of development:

1. Market formation.
2. Nationalization, concentration and monopolization (mostly in the form of state monopolies).
3. Market liberalization.

Historical context:

• The liberalization process began in the second half of the 20th century., after World War II.
• This was a reaction to unsuccessful attempts to make centralized state markets effective.
• In parallel, a powerful scientific base was formed for the analysis of specific markets, especially the electricity market.

The example of Great Britain:

It was there that large-scale attempts at liberalization first took place energy markets, even those where natural monopolies hold a significant share.

Specificity of electricity as a product:

• Production = consumption: electricity can only be produced when it is consumed.
• Closed loop: its production requires synchronous interaction between generation and consumption.
• Conditional storage: electricity cannot be stored in its pure form, but is only transformed into other types of energy or into physicochemical processes (for example, in batteries).
• This creates additional complications for the organization of efficient markets, since it is necessary to balance supply and demand in real time.

It is precisely because of this specificity that the electricity market has become a field for implementing the most modern scientific approaches to the formation, optimization and modeling of market processes.

As part of fulfilling the requirements of the Third EU Energy Package, Ukraine joined the Energy Community Treaty as a candidate country for EU membership.

Legislative framework:

• The Law of Ukraine “On the Electricity Market” (entered into force on July 1, 2019) introduced a modern market model.
• This model maximally complies with European standards and is aimed at integration of the Ukrainian market into the EU market.

Segments of the electricity market in Ukraine (synchronized with the EU):

1. Market of bilateral contracts.
2. Market “day-ahead”.
3. Intraday market.
4. Balancing market.
5. Market of ancillary services.

Feature:
All these segments are parts of a single economic and mathematical model of market functioning, which takes into account the specifics of electricity as a product (consumption occurs simultaneously with production).

3.2. Natural gas market

In Ukraine, active work is underway to implement the natural gas market in accordance with the requirements of the Third EU Energy Package.

The market structure includes:

1. Wholesale market.
2. Retail market.
3. Balancing market.

At the same time, there are differences from the European model, which creates additional challenges in the reform process.

3.3. International integration

• ENTSO-E (European Network of Transmission System Operators for Electricity) — unites 43 electricity transmission system operators in 39 European countries. Ukraine is already integrating into this network.
• ENTSO-G (European Network of Transmission System Operators for Gas) — a similar structure for the natural gas market. Ukraine’s integration into this network is only at the theoretical stage due to the complexity of reforming the gas sector.

3.4. Other energy markets in Ukraine

• Petroleum products market.
• Coal market. Despite the course towards decarbonization and energy transformation, the use of coal as a strategic security raw material remains relevant. However, coal market reform is urgent and requires political and economic solutions.

4. The role of the national regulator in the functioning of energy markets

 Need for a regulator:
Modeling modern energy markets is impossible without a national regulatora.

• In the context of a large number of natural monopolies, demonopolization is possible only if separation of individual types of activity is carried out.
• If generation, distribution and supply are concentrated in the same hands, a monopoly advantage is formed, which distorts market relations and reduces their efficiency.

Ukrainian experience:

• Previously, Oblenergo could simultaneously engage in generation, distribution and supply of electricity, which created significant monopolization.
• In response to global trends, demonopolization was introduced in Ukraine.
• It is legally stipulated that distribution, generation and supply cannot be in the same hands at the same time.

Modern market structure:

• There is an open market for electricity supply, trading and retail.
• Individual companies are engaged in generation, and the wholesale market is separated.
• Such a division limits monopoly influence and stimulates the development of competitive relations, which is the key to efficiency and meeting consumer needs.

National regulator of Ukraine:

• NKREKP (National Commission for State Regulation in the Spheres of Energy and Utilities) is the main body responsible for the effective functioning of the energy markets of Ukraine (electricity, gas and utilities).
• Formally, the NCREKP is a central executive body subordinate to the Cabinet of Ministers.
• Problem: The regulator does not have full independence, which creates a risk of political influence on its activities.

Powers of the National Commission for the Regulation of Energy and Utilities of Ukraine:

• Licensing the activities of market participants.
• Regulating tariffs and investment policy.
• Approving the rules for the functioning of markets.
• Ensuring competition.
• Protecting consumer rights.

European standards:

• The regulator must be independent of state authorities and political influence.
• This is a key condition for the effective functioning of liberalized markets.

5. European institutions and regulatory mechanisms

REMIT (Regulation on Wholesale Energy Market Integrity and Transparency)

• EU Regulation on integrity and transparency in the wholesale energy market.
• Main objective:

• preventing price manipulation,
• combating insider trading,
• guaranteeing fair competition.

• For Ukraine, the implementation of REMIT is taking place with certain difficulties, but this regulation is an important part of the institutional model of European markets, which our country is gradually adopting.

ACER (Agency for the Cooperation of Energy Regulators)

• European Agency for the Cooperation of Energy Regulators.
• Main functions:

• coordinates the work of national regulators in the EU countries;
• promotes the integration of energy markets;
• ensures their competitiveness and security;
• develops common standards for the functioning of the EU internal energy market.

Energy Community

• An international organization created to integrate non-EU countries into the European energy space.
• For Ukraine:

• it is a key tool for adapting national legislation to EU requirements;
• helps implement energy reforms;
• ensures synchronization with the European political and economic field;
• The Energy Community Secretariat manages significant support funds, including multi-billion programs for the Ukrainian energy sector.

Benefits of integrating Ukrainian markets into European ones:

• increasing transparency and investor confidence;
• increasing competition and reducing monopolization;
• access to European financial and innovation instruments;
• increasing energy security and sustainability;
• integration into the single EU energy system.

For Ukraine, integration with the EU market is not only about fulfilling formal obligations. This is a way to increase reliability, reduce systemic risks, attract investment and create conditions in which the consumer receives a better price and service, and the system – greater flexibility and stability.

Active links (NPA, standardyou, resources)

• Law of Ukraine “On the Electricity Market” (Vedomosti Verkhovnoi Rada (VVR), 2017, No. 27-28, Art. 312)  https://zakon.rada.gov.ua/laws/show/2019-19#Text
• Law of Ukraine “On the Natural Gas Market” (Vedomosti Verkhovnoi Rada (VVR), 2015, No. 27, Art. 234)  https://zakon.rada.gov.ua/laws/show/329-19#Text
• ENTSO-E (European Network of Transmission System Operators for Electricity) https://www.entsoe.eu/
• ENTSO-G (European Network of Transmission System Operators for Gas) https://www.entsog.eu/
• NKREKP (National Commission for State Regulation in the Energy and Utilities Sectors) https://www.nerc.gov.ua/

• REMIT (Regulation on Wholesale Energy Market Integrity and Transparency) https://eur-lex.europa.eu/eli/reg/2024/1106/oj/eng

• ACER (Agency for the Cooperation of Energy Regulators) https://www.acer.europa.eu/
• Energy Community https://www.energy-community.org/
• Explanation on the Bilateral Contracts Market https://www.entsoe.eu/about/market/

• EU Electricity Markets: Structure and Integration https://energy.ec.europa.eu/topics/markets-and-consumers_en
• European Energy Strategy (European Green Deal) https://commission.europa.eu/strategy-and-policy/priorities-2019-2024/european-green-deal_en
• Ukraine and integration into the EU market (Energy Community, Ukraine page) https://www.energy-community.org/contracting-parties/Ukraine.html
• Liberalization of the electricity market in the United Kingdom (Ofgem) https://www.ofgem.gov.uk/
• Scientific approaches to balancing energy systems https://www.iea.org/energy-system