Script excerpt: Riccardo Puliti, EBRD Managing Director for Energy and Natural Resources on 24 June 2014

Speech delivered by: Ricardo Puliti
Event:  Euro-Med conferencea in Rome 
Date: 24 June 2014

Riccardo Puliti, EBRD Managing Director for Energy and Natural Resources, delivered these remarks at the Euro-Med conference organised by the Observatoire Méditerranéen de l’Energie (OME) in Rome on 24 June 2014.

I have the pleasure to start our discussion on Market Structures and Business Models today with some introductory remarks. I will try to be brief so there is ample time for the panel discussion and your questions.

I would like to address the following three points which I think are crucial in any discussion about energy markets and business models in the Mediterranean region

  • How do market models deliver efficient energy markets
  • The importance of policies and regulation; and
  • The need for regional Integration

I am not telling you something new if I say that over the coming years the Mediterranean region will need a lot of investment in new energy infrastructure throughout the value chain – in order to satisfy local demand, help its economies grow and also to generate income and benefit from trading energy resources across borders. This energy infrastructure will have to a significant extent be funded by the private sector as well as financial institutions. And all these investments will require efficient energy market models that can attract and give the right signals to investors.

Reliable market prices that reflect the underlying costs are key to a functioning market. From a market design perspective it is important that prices reflect the relevant cost of generation, i.e., that prices generally reflect the short run marginal cost, and that these wholesale prices are passed-through and reflected in end-user prices. To facilitate investment, it is important that reliable price references are established. Transparent prices are also important for market participants. Trustworthy prices also depend on a well-functioning, neutral and non-discriminatory price setting process.

Market structure impacts on the performance in the power sector. If poor decisions are made on the electricity market structure, technology and timing of investment, cost increases may be passed on to consumers with negative consequences for economic performance and social welfare. The institutional model of a publicly owned monopoly industry means risks may be shifted disproportionately to consumers or taxpayers. Furthermore, information asymmetries could leave the regulator with an incomplete picture of costs and potential efficiency gains.

Alternative electricity market models have emerged. The first is competition for access to the electricity market, including variations of the single buyer model. This is where the private sector is encouraged to invest in new power-generation capacity through tenders or auctions. If well managed, competition can result in improved efficiencies in technology and investment choices. When a comprehensive restructuring of their power sectors is not technically feasible or politically desirable the single buyer may be the only remaining alternative to attract private capital. The second electricity market model involves competition between electricity generators and suppliers to provide electricity to consumers. In the latter model, competition is managed through a power exchange or bilateral markets or both, and market risks can be managed through derivative financial markets. The debate on centralised versus decentralised market designs has played out in various countries around the world over the past three decades. This debate will continue with the additional complication of government policy objectives on climate change which as in turn reintroduced the consideration of capacity payments in market design.

Governments have to consider the spectrum of the different market models and decide how their country can move along this spectrum and where it will find an adequate place that allows competition to drive efficiency and the best outcome for its economy and its citizens.

Choosing a market model is also closely tied to another question - that of the best policies and regulations to accompany the chosen market model.

Despite wide agreement that sound policy making and independent regulation are important for efficient energy markets, we tend to see a lot of instances where policies are un-predictable or discretionary and where a lack of power of national energy regulators hinders effective regulation. We see policy makers intervene bluntly in the energy sector – putting in place retroactive policies with significant costs to the energy system including consumers. Similarly, we see regulators neither have the powers nor the resources in terms of staff and financing to do their job properly and keep being subject to political interference.

Yet, well-functioning and sustainable energy markets need sound regulation, and they also need predictable and transparent government policy making. Why?

Even with fully privatised industries, such as banking, we have seen that the state may continue to play a role as ultimate guarantor of economic stability. Such stability is equally important in the energy sector. Widespread energy shortages can have significant ramifications for individuals and the economy as a whole. This leads most governments to retain close connections with the operation of the industry which can also facilitate the achievement of policy objectives such as electrification or the reduction of emissions.

Regardless of ownership, the government usually maintains ultimate control in the event of emergencies. Although necessary, this can be perceived as introducing some form of ‘moral hazard’. It is important to counterbalance this risk with a strong legal framework for policy formulation that promotes active stakeholder engagement through open and transparent consultation.

Secondly, throughout the range of market structures outlined above, independent regulation is essential. Regulators should be accountable, predictable, focused and efficient in order to ensure that energy markets can deliver the incentives needed to support investments without leaving placing excessive burden on consumers. This will benefit each and every citizen, through promoting more competitive prices, improved security of supply, better standards of service and better levels of consumer protection.

As the Mediterranean – and especially the southern and eastern Mediterranean countries are looking to invest significantly in new energy infrastructure in the years to come, sound policymaking and independent regulation should be strengthened so that it can support and enhance the efficiency of the chosen market model.

This brings me to my last point today – which is about the need for regional integration.

In Europe we have talked for a long time about promoting market structures that lead to better regional integration and at the same time more efficient energy markets. However, regionalisation of energy markets, trading and also solidarity is an issue that applies universally and is equally relevant for the Mediterranean region.

Why is this?

Regional integration is of significant importance for the Mediterranean region because of the large energy investment needs faced in many if not all of the Mediterranean countries. These much needed investments will have to be made as energy demand is growing and the region wants to better benefit from its domestic resources – whether those are fossil fuels or renewables. But these benefits will be even higher when markets are better integrated – providing savings on investment expenditure, better efficiency through cross-border trading and at the same time better energy security for each country and its citizens.

Currently, gas and electricity markets in the region are separated on national lines and are dominated by one or a handful of incumbent companies. Missing interconnections make it impossible to benefit from system efficiency and during times of crises do not allow us to show solidarity or merely sell energy across borders and supply our neighbours. Nevertheless I know that there is a great awareness here in the room, not only because of our discussion on energy security this, morning that properly interconnected markets can contribute significantly to energy security and efficiency.

Energy markets should therefore not only be seen through a national lens – but also need to be considered in a regional setting. Even though I reckon that in the short term, in the Mediterranean questions about domestic energy policy and market structures will dominate, I urge everybody to start the journey towards more regionalisation. And to set up market structures in such a way that they allow new cross-border infrastructure investments – which will ultimately promoting efficient use and trading of energy resources, better energy security and more competitive energy prices.

In the medium term, regional, integrated energy markets will be indispensable for a secure, sustainable and affordable energy supply in the Mediterranean.