Vattenfall response to: ACER pre-consultation Energy Regulation: a bridge to 2025

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1 Vattenfall AB Identification number in the EC register: Vattenfall European Affairs Rue de la Loi, Brussels Vattenfall response to: ACER pre-consultation Energy Regulation: a bridge to 2025 Vattenfall is happy to contribute to ACERs initiative to consult stakeholders on regulatory priorities until While our comments to the three discussion papers can be found more in detail below, there are a couple of issues that are reflected in several of our answers to the consultation questions and that we want to emphasize in particular: As markets will always be confronted with unforeseen circumstances, market design must be robust, address general framework conditions and be flexible enough to accommodate future developments. It is neither possible, nor desirable to plan the market in detail and the ambition should be to have as little regulatory intervention as possible. We want to support ACERs approach that primary focus should be on fully implementing the Third Package. This is particularly important for those elements of the Third Package that help to improve the accuracy of price signals (e.g. the market Network Codes) and which should have absolute priority, before ACERs focus shifts to developing new regulation. Further regulatory intervention should primarily focus on getting price signals right. Price caps in wholesale markets need to be removed, regulated prices in retail markets need to be abandoned and DSO s need to incentivise smart technology where suitable. Vattenfall strongly believes that many of the challenges energy markets are currently facing - i.e. lack of demand response, and flexibility - are caused by the absence of correct price signals. ACER should acknowledge national and regional differences. Harmonization should not be a goal in itself, but be carried out where necessary to create a level playing field and accurate price signals. On a wholesale market level this means that the implementation of the target model should allow for regional solutions where it does not interfere with trade flows. On a retail market level the harmonization requirements will probably be lower, but should not interfere with competition. The focus of DSO unbundling should further be to fulfil the Third Energy package and the Energy Efficiency Directive (2012/27), and mitigate the existing exemptions that prohibit the development of a level playing field. The existing unbundling rules will ensure that smart meter data is used and delivered in a non-discriminatory manner. At this point, we do however not believe that ownership unbundling will help making the energy system

2 future proof. Access to data and data transparency is not improved by ownership unbundling of DSOs. Consumers should increasingly be provided with the possibility to decide if they want to be exposed to real time prices or want complete price certainty. Real time balancing information (and prices) will therefore increasingly be needed from specific customers. Similarly it should also be up to consumers to determine if they want full supply adequacy contracts or contracts with possible load reductions. Vattenfall is of the opinion that flexibility should be stimulated by price signals and a separate support instrument for flexibility is inappropriate. Flexibility is best rewarded by introducing transparent market prices that give accurate scarcity signals. Especially the refinement of price signals in intraday and balancing markets should be a top priority for ACER, as that will help a lot increasing the flexibility of the market. Not only will it help the development of demand response, but it will also make sure that investments are being made in the type of generation capacity that are actually needed. When demand is increasingly able to respond and becomes price setting in scarcity situations, the missing money problem that some countries try to solve by implementing capacity markets, will also largely disappear. All market actors should be increasingly responsible for their own imbalances. This goes for both conventional and RES generation, but also for demand that participates in demand response programmes. In order to be able to handle these imbalances every market parties should have direct or indirect access to well functioning (cross border) balancing- and intraday markets. With increasingly interconnected system areas and increasing flows between these areas enhanced coordination between TSO s (and to a lesser extent also between DSO s) becomes increasingly important. Vattenfall therefore encourages ACER to evaluate how communication can be improved, also with the goal to improve the utilization of available cross border capacity. We hope that, going forward, ACER will take these comments into account and use them to establish a regulatory framework that enables the development of an efficient European energy market that supports both the sustainability goals, security of supply and competitive prices. In the process of getting there, we appreciate that ACER remains in close contact with the market and other important stakeholders.

3 Comments to Overarching Paper : Q1. Do you agree with this over approach? Would your emphasis be any different? ACERs focus on implementing current regulation before new regulation is developed is broadly supported. First the Third Package should be fully implemented in a way that proper price signals can develop. As soon as these price signals exist the need for other, already considered, regulation will disappear. This especially relates to the issue of Capacity Remuneration Mechanisms, where more accurate price signals in (especially intraday and balancing) markets would support the development of demand response, more flexible generation that can ramp up and down fast and would strongly reduce the need for CRMs. In that sense, Vattenfall is also broadly supportive of the way forward proposed by the EU Commission in its Guidance to Member States on state intervention in electricity markets from November 5, Q2. Do you agree with this broad analysis and/or do you have further suggestions? Vattenfall in general agrees with ACERs analysis that predicts more RES, more distributed energy generation and consequently less certain supply & demand patterns. In general Vattenfall is of the opinion that ACER should distinguish between wholesale markets on one side and retail and DSO markets on the other. Regulation for electricity and gas wholesale markets in Europe should be harmonised to a very large extent to be able to deliver accurate price signals across all borders and timeframes. However, it should be possible to have regional implementations where it does not interfere with cross border trade flows. For Retail and DSO markets more regional variation can be accepted. In all cases ACER should carefully consider the cost and benefits of full harmonisation. Because wholesale markets are increasingly interconnected, it will be important to keep an eye on regional and national developments that will have a big impact on the EU market. This especially relates to differences in the speed of renewable development and the implementation of capacity markets. In both cases countries and regions move at a different speed and the impact of this on the internal energy market will be considerable. For these wholesale market issues ACER should promote regional and cross-border solutions and stimulate that also regulators and TSOs increasingly cooperate across borders. It is crucial that ACER and national regulator keep an eye on the likely negative impact of national CRM on cross border capacity development; they could reduce possibilities for sharing reserves and hindering the development towards shared merit orders across borders. The regulators should ensure that any such initiative doesn t impede trade between countries. Instead trade should be promoted and facilitated to create a path towards long run cost efficient solutions across Europe. Q3. Do you think the list of suggested measures is complete or do you have further suggestions? Do you think that the requirements for infrastructure investments in gas are the same as in electricity? There is a vast difference in cost allocation of infrastructure investments between the two commodities. In gas, investments are often not realised unless market parties commit to paying

4 for up to 80% of the total investment cost, by signing up to capacity contracts for several years. In addition to this large market commitment, transmission tariffs are not known for more than 1-4 years ahead of time. This means the above mentioned market party commitment is basically a blank cheque. Vattenfall believes that considering the shift to a book-as-you-need/use mechanism, with an increasing share of tailor-made transmission booking a revision of the existing model is required. When viewing the differences between the investment in infrastructure of power and gas, it is important to keep in mind the physical differences between these commodities. Power generation is more localised, requiring a meshed local transmission grid. For gas, the sources of gas production are often located outside the market. This - combined with the ability to store gas in the pipeline - less local meshing is needed, while a higher level of cross-border capacity is required. This implies that it is more important for gas to ensure that cross-border investment regulation, including cost allocation across borders, is put in place. In general it is also important to keep considering local differences that are often based on current market regulations. A locally oriented design has to be taken into account when thinking about widening the scope of Network Codes which might be counterproductive for an efficient Smart Grid deployment. Locally differences will also play a role for designing network tariffs. In this aspect there will also not be a one size fits all approach. What further ideas do you have on the future role of consumers? Vattenfall largely agrees with the development sketched by ACER with regard to the future role of consumers. Consumers will become more active and increasingly engage in the energy market, also with their own generation. This also requires products that are better tailored to the needs of consumers, which are best supported by increased competition. Therefore and where not already apparent - competition should also be established in retail markets. There are still several retail markets in Europe where competition is not apparent, retail tariffs remain regulated and the entrance of new market participants is obstructed by existing market rules. Here, EU and national regulators should increase their efforts to establish the right framework conditions for competition based on the requirements in the Third Package. Consumers should be able to decide for themselves if they want to be exposed to real time prices or want complete price certainty. Similarly it should also be up to consumers to determine if they want full supply contracts or contracts with possible load reductions.

5 Comments on paper on Consumer and Distribution Networks General comments The ACER discussion paper mentions structural reforms, such as ownership unbundling or European efforts to integrate electricity retail markets, as potential routes for enhancing the operation of the retail market. At this point, we do not believe that ownership unbundling will help making the energy system future proof. Access to data and data transparency is not improved by ownership unbundling. ACER should focus on the implementation of the Third Energy Package and Energy Efficiency Directive (2012/27), and current exemptions due to the de minimus rule, rather than on DSO ownership unbundling. The discussion about smart meter roll-out and the design of network tariff pinpoints the current challenges and there will be the question how smart solutions can be addressed in regulation. These issues are crucial concerning price signals, demand side management and energy efficiency. But due to local differences and based on the current market regulation, efficient solutions must be locally oriented. A locally oriented design refers to the most beneficial implementation of smart meters and is also of particular importance if network tariffs should contribute to the incentives for customers. The availability of standardized smart metering data in a non-discriminatory manner is important. National legislation will take this into careful consideration and balance with data privacy issues. Still transparency will be of increasing importance and therefore would be of interest for European regulation. With full transparency of standardized data, DSO will have no advantage vis-à-vis other actors in the market. Besides local differences the challenges for gas and electricity grid operators also differ substantially. The integration of the increasing amounts of renewables is typically subject to the electricity grids. Smart Grid concepts are therefore manifold - not only on a locally level but also between the different branches. In addition it will be of increasing and substantial importance that regulation does not hamper investments of grid operators. Also many DSOs are facing huge increases of replacement investments and are challenged by the integration of distributed generation and obligatory implementation of smart meters. Tariff regulation should be structured in such a way that it facilitates these investments. This also includes funds for demonstration projects that involve customers and other relevant market actors, which are very important to gain experience in these new business areas. Regulators must allow temporary exceptionally tog for maximizing knowledge gains. C1. Do you think that further European level measures should be taken to enhance the operation of retail markets to the benefit of consumers? Regulated end-user prices should be abolished. Consumers should be given the opportunity to react on price signals and thereby gain more control of their energy bills. Any design measure to address the role of consumers must be based on undistorted market prices to all market parties. End-user prices should be a result of competitive processes not regulated and centrally decided tariffs. It should be the consumer s choice which level of price security she wants. It should be investigated along the roll-out of smart meters how consumers may choose an individual level of supply adequacy based on his/her respective preferences. Thus, the variety of contract forms to choose from would span over two dimensions i.e. the

6 individually decided supply adequacy level and the level of price security. In the first dimension the choice would span from full supply adequacy contracts to contracts with possible load reductions. In the second dimension the choice spans between fixed price contracts and contracts that expose the consumer to real time prices. Market participants have the responsibility to develop fair contracts for active as well as non-active customers. C2. Can you suggest ways in which we could enhance the voice of consumers in the development of Europe s energy market? Efficient and competitive markets will give customers the best deal. Where not already established, also competition in retail markets should be ensured. Active consumers, that can react on market price signals will provide flexibility and will be rewarded with increased control of their energy bill. The abolishment of regulated market prices throughout Europe thereby is the single most important issue. It supports affordability, reliability and empowered customers. Consumer should be given the opportunity to individually decide what type of contracts they want. C3. What are the main questions that you consider the proposed CEER review should address with regard to the future role of DSOs and also to ensure that the regulation of distribution networks remains fit for purpose in 2025? The DSO has the physical connection with the customer. With the roll out of smart meters they will be able to collect increasing amounts of data. Regulators and the European Commission verify if tasks currently performed by the DSO can be better addressed by market participants and vice versa (e.g. EG3 report of the EC Options on handling Smart Grid Data ). A decision should be taken if these tasks are open to be performed by the market or should be carried out by the DSO under regulation. A lack of clarity on these issues will obstruct further development of the market and should be avoided.

7 Comments to paper on Electricity E1. Although adequacy issues are not likely to disappear completely, do you agree that the current primary focus on levels of adequacy will likely be expanded to emphasise a later priority focus on flexibility? The adequacy and flexibility issues are closely related. A socially acceptable level of supply adequacy is crucial in building and maintaining society's confidence in the electricity market. The share of intermittent and inflexible production will increase and will require accompanying flexible resources to ensure an acceptable level of supply adequacy. In this respect the importance of extending the transmission network should be further emphasized as it is one of the cheapest options available to increase the efficiency and flexibility of the electricity market. Flexibility is a term for ramping generation or consumption up or down within a certain amount of time. Both ramping-up and ramping down is related to price signals. Only if market prices are non-distorted (e.g. no price caps) the market price will incentivize production units with the right characteristics. An important measure to support long term supply adequacy is to utilize the price sensitivity on the demand side as well. Especially with increasing levels of intermittent generation it will be very important that the customers can react on prices, increasing the basis of market based solutions. Developing demand side response will not only make the electricity market more robust, it will also reduce the need for (unprofitable and costly) back up capacity and hence reduce the need for capacity remuneration mechanisms. This also requires that real time balancing information (and prices) will be needed from specific customers (depending on the yearly consumption, the potential to shift load, prosumers) that allows market parties to react and anticipate on price movements. Instead of introducing sufficient generation capacities by capacity mechanisms, Member States should rather rely on the market incentives of proper price signals to facilitate sufficient generation capacities and demand response. If the market can react properly, a rather limited Strategic reserve of old installations outside the market can efficiently ensure the aspired adequacy level. E2. Should we seek to further define, measure and develop flexibility in addition to the initiatives that are underway? If so, how could this best be done and in which market time periods? Flexibility is best rewarded by introducing transparent market prices that give accurate scarcity signals. A separate support instrument for flexibility is inappropriate. The main reason is that flexibility is hard to measure. A manifold of flexibility resources exist on the supply, but also demand side. But supporting one flexibility option reduces the income for other perhaps cheaper flexibility options. ACER should therefore avoid introducing additional tools to foster specific types of flexibility, but focus on the development of accurate price signals and the removal of barriers that prohibit participation of flexibility resources in all but certainly balancing markets. E3. What are the market-based routes for flexible tools to participate? Vattenfall sees the fulfilment of the target model, timely implementation of EC network codes and efficient cross-border trades through strong regulatory incentives to allocate cross border

8 grid capacity at all market time horizons, as crucial steps to support and unleash the full potential of flexibility in the current and future system. Concrete measures that preferably should be evaluated by ACER for potential application are: All market actors should be increasingly responsible for their imbalances in order to provide sound economic incentives to plan and forecast generation. This also implies that RES-E should be further integrated in the market and should be increasingly made responsible for its own imbalances. RES should however have access to well functioning and liquid intraday- and balancing markets to be able to cover their imbalances. Make sure that the possibilities for cross-border trade in all market time periods are exploited to enable an efficient use of resources. E4. What measures may be required to ensure that the market receives the most appropriate signal for the value of flexibility? Flexibility must be valued through efficient prices that reflect the balance between overall supply and demand. This also requires the abolishment of price caps and other barriers that distort price formation. The decision to utilize flexibility from a particular flexibility resource and provided by different market players must always be subject to a market based valuation and selection process. TSOs and DSOs should buy flexibility from the market. Flexibility resources should for the least possible extent be financed via regulated tariffs that would keep them exclusively ready for network operations. Additional effort should be given in establishing real time balancing information where market participants can anticipate and proactively react upon, like for example already largely is the case under the Dutch balancing system. This is also of great importance for developing Demand Side Response. Furthermore the price for a particular market time period should preferably be based on the pay-as-clear principle and transparently revealed. For the further development and integration of balancing markets it is important that the regulatory framework develop towards a single European Balancing Mechanism. Potential add-on to existing market design that Vattenfall encourage ACER to evaluate are: Currently the intraday market is designed with continuous trading. For the future it should be investigated if this set up could be enhanced by intraday auctions e.g. by ending the intraday market time period with an auction. In case intraday auctions are introduced they should be settled with the pay-as-clear as clear principle as is done in the day ahead market and be implemented as a complement to the target model. In order for Demand Response to develop the market needs to have access to real-time (aggregated) consumption data of all large- and mid-scale consumers; and not only those customers engaging in Demand Response. This requires a real-time metering and information to the retailers with a frequency of approx. 1 minute. In order to have an efficient relation of cost and benefit, it would be sufficient to communicate the aggregate consumption for each balance perimeter to the balance responsible party. This should be achieved only by an improved communication of the metering data with the existing meters rather than rolling out new meters. The time period between imbalances are measured and settled should be shortened. The pros and cons of moving gate closure from day-ahead closer to the time of delivery to further facilitate the integration of intermittent RES.

9 The possibility of implementing an auction based system in addition and complement to continuous trading in Intraday In addition ACER should promote a further balancing market integration towards a common merit order E5. Do you think that other, for example institutional arrangements should be considered? Is greater TSO and DSO coordination required? If so, what should NRAs do to facilitate this? With increasing levels of cross-border electricity trading and flows, also improved TSO-TSO and TSO-DSO coordination is required. A facilitated flow of information combined with deeper coordination of system operation and system development imply increased socioeconomic efficiency through better use of existing as well as future transmission system. ACER must look for ways to further deepen and improve coordination of system operation reaching beyond the scope of the network codes. Increased co-operation across the current system borders is key area for further development of the internal market. Vattenfall encourages ACER therefore to evaluate how cooperation between especially TSO s could be improved. E6. How should regulators facilitate demand side participation (including demand side response and electricity storage)? Regulators should facilitate demand response by abandoning price caps in the wholesale market, abandon regulated prices in the retail market and incentivise DSOs to install smart technology where suitable. Smart meters are decisive for hourly measurement and settlement/billing. With technology enabling controllability e.g. remote disconnection of a particular customer and active consumer participation through two way communication innovative solutions for demand side participation is expected to emerge, if price differentials exist that make demand side participation worthwhile for the customer In addition to accurate price signals and necessary technology, demand participation can be stimulated as for example has been the case in Sweden and the rest of the Nordic market. In Sweden demand was included in the strategic reserve which triggered activities within the large electricity intensive companies. Additionally, the market place Nord Pool has actively been pursuing demand response which could be used as examples in the efforts to facilitate demand side participation where it is less developed. All market actors should be increasingly responsible for their own imbalances, thus retailers should not be responsible for the imbalances of other parties (e.g. third parties that are offering DSR solutions to our customers i.e. Aggregators). Next to that reserve power products should be technology neutral and enable the participation of demand and supply. Vattenfall encourage ACER to evaluate whether the existing roles in the electricity system needs to be evolve in order to provide the structure that may make best use of smart meters and smart grids. E7. How can NRAs support, or incentivise TSOs and DSOs to invest in smart networks. What actions are needed, in particular from regulators, to promote more active distribution networks? Do we sufficiently reward avoiding dumb investments?

10 Generally regulators should avoid radical changes and any changes put forward should be tested in smaller scale before full implementation. It is difficult to foresee how a regulatory mechanism avoiding dumb investments should be constructed (see also our general comments in the Consumer and Distribution section). E8. How should NRAs influence the competition debate, for example on support schemes, regulated tariffs, capacity remuneration mechanisms, etc? NRAs should be working for a level playing field both across different generation and consumption sources, and across borders. The energy-only market has been distorted in some markets where certain technologies have been heavily subsidized. This is for example true in Germany where the market had to deal with substantial shares of RES that have come online in only a limited period of time and has created large overcapacities in the residual market. We may now have to accept local and regional solutions to problems created, which could have been avoided by a more stepwise introduction of RES. In an overall scheme such solutions should not be allowed to impede trade between countries. Instead trade should be promoted and facilitated to create a path towards long run cost efficient solutions across Europe. Thus any measures as local capacity remuneration mechanism, support schemes etc should not decrease the possibilities for trade. It is important that the NRAs are active in the debate when we get price spikes, see for example how the heads of the Swedish competent authorities defended price spikes during the winter E9. To what extent should the relationship between competition in electricity and gas markets influence regulators activities? Could regulatory action on the gas market, help solving the flexibility problem of the electricity market? Again, flexibility is best promoted by having correct price signals. Market design should be robust and be able to accommodate future developments. The evolving Network Codes will form the base for European market rules and the development of the target model. It is however difficult to plan a market in detail and this should also not be tried. The NRAs should not favour particular technologies, but instead enable a connecting market structure that allows all sources of power production to provide the required flexibility through market based signals. In addition, it is likely that regulatory action relating to the existing differences between power and gas market design, f.i. relating to nomination schedules and start of the gas and power day and year, could be optimised to facilitate a level playing field between power and its fuels. E10. How should regulators remove barriers to entry for new supply sources? Facilitate a level playing field and maintain focus on public acceptance issues. In the end Vattenfall recommends that market signals are used to accommodate the entry of new sources. E11. What actions, identified in these papers, should regulators prioritise? Above all ACER should prioritize the introduction of transparent market prices relieving accurate scarcity signals in all market and across all time periods. The development of efficient cross-border intraday- and balancing markets thereby is an area that requires special concern given the growing share of intermittency in the system.

11 The efficient allocation of transmission capacity in all time frames is essential for well functioning markets. System operators should allocate capacity wherever possible in all time frames. For the forward time frame it is important to allow for regional implementations e.g that the capacity can be allocated by using already existing instruments when suitable. In the Nordic region a suitable implementation would be that TSOs allocate transmission capacity to Nasdaq/OMX for further allocation in auctions of Electricity Area Price Differentials (EPADs). This would enable implementation of the market rules building on the existing Nordic market model. Regulators should explore the possibilities to individualise supply adequacy e.g. as a cost efficient solution to the present discussions on need for Capacity Remuneration Mechanisms. In addition possible efficiency gains from coordinating market operations and system operations in regional entities, possibly spanning over more than one control area, should be thoroughly investigated TSOs should provide transparency to the market with real-time and accurate data per bidding zone. The data should consist of available transmission capacities and market data differentiated between aggregated supply and demand as well as and import and export levels. These data are a crucial basis for a well-functioning market and currently not always published by TSOs