The fall in economic activity caused by the spring 2020 shutdown has led to a drop in industrial production and thus in energy consumption by firms. This sudden drop in demand due to the pandemic is a natural experiment that tests the resilience of electricity market mechanisms. The French system for supplying independent electricity retailers with nuclear electricity, the so-called ARENH, may not survive it.
The demand shock and its rebound
When economic activity resumes after the general anesthesia applied to combat Covid-19, the survival of companies will depend on their ability to catch up for lost time. In the energy sector, the oil and gas not purchased for transport and industrial processes in March-April 2020 will only be partially compensated for during the rest of the year. For road transport, for example, trucks that did not run in spring will not run in autumn beyond the hours allowed by technical maintenance and regulations protecting drivers. The same applies to air transport. These reductions in activity have at least one advantage, the improvement in air quality. But there is a risk of seeing an increase in the number of company closures if they are not placed under a commercial and fiscal umbrella.
In the electrical industry, things are a little different. Consumption has undeniably fallen both in the US and in Europe. According to the French Energy Regulatory Commission, the drop is 15% on average compared to the level usually seen in March. Production has therefore also fallen since electrical energy is not storable. However, the decrease is less marked than in the economy, as part of the fall in electricity consumption by industry, trade and rail transport is offset by an increase in the residential sector. In fact, households are forced to stay at home and consume more for electric heating, cooking, the Internet, and teleworking. The result is a daily consumption curve during the week which differs little from that at weekends, and a smoothing of peaks at the end of the day.
This period is also a reminder of how essential electricity has become in the domestic life of developed economies. It is easy to imagine what the self-quarantine would be like without electricity. Everyone hopes that the supply of electricity will continue without failure. RTE, which is responsible for balancing the French system, and the two marketplaces epexspot and Nordpool have signed a "Business Continuity Plan for Electricity Markets". It considers the activation of a downgraded mode depending on the availability rate of RTE staff in charge of network control activities within the national dispatching center. Residential consumers should not be affected as production plants and markets are now automated.
A price that adapts to the wholesale market
While for electricity consumers everything should go well, the same cannot be said for producers. As in most industries, the fall in consumption is inducing huge overcapacity. But it is more serious for electricians, because we have built electrical systems to avoid blackouts in 99.9% of cases (a handful of outages are tolerated out of the 8760 hours in a year). Our system is therefore chronically over-capacitated due to the difficulty of storing for bad days, as only pumped storage power stations are capable of providing this storage. In other words, since we cannot store the product, we are building the capacity to produce it instantly. Therefore, when demand collapses, competition between producers to serve residual demand is exacerbated, resulting in a sharp drop in prices. At the end of February, the MWh was trading at around €50 on epexspot. At the end of March, hourly prices were below €25, and episodically negative.
This drop in prices is welcome for commercial consumers who buy electricity on the wholesale market. But it is temporary, and this is fortunate given its cause. The economy will still need a lot of electricity in the near future. We must then avoid today's price drop causing production site closures, leading to disproportionate price increases next winter. We will need this production capacity in the near future if transition to the electric car materialize.
Lower wholesale prices should also allow electricity suppliers without generation assets to survive to the quarantine period since the price at which they resell to their customers is contractually fixed. Unless they have taken positions in the electricity market à la française, the "Accès Régulé à l'Electricité Nucléaire Historique" (ARENH).
Electricity market à la française
In a previous post, we recalled the mechanism of the ARENH which allows all alternative suppliers to be supplied with electricity by EDF under the conditions set by the NOME law of 7 December 2010. Until 2025, the price of the ARENH MWh is set at €42 and the overall volume allocated to the mechanism is limited to 100 TWh/year. As its name indicates, it is a resource allocation mechanism whose price is regulated. Operators bid for quantities that are rationed if demand exceeds the supply inelastically fixed at 100 TWh/year. This mechanism relieves a historically regulated industry that is wary of markets.
The recent adventures of the ARENH are reminiscent of those horror films in which the first part shows heroes who manage to escape from some monstrous entity by locking themselves up in an enclosed space, and the second tells how the survivors, who made the mistake of locking the creature in with them, will try to escape from this refuge transformed into a trap. In fact, at the end of 2019 the economic activity forecast for 2020 was good. In anticipation of high prices on the wholesale markets (the malevolent beast), 73 suppliers took refuge in the ARENH by submitting requests up to 147 MWh. As Procuste applied its principles of equity, CRE decided to allocate to each supplier 100/147 = 68% of its demand. But then came the pandemic, the demand shock and the resulting fall in wholesale prices. Suppliers who thought they had escaped the market mechanisms found themselves obliged to buy electricity at a price of 42€, which they could not sell in full to their customers. They will therefore have to dispose of the surplus on the wholesale markets, the evil entity which now has average prices of around €20.
To escape this financial calamity, some suppliers have requested the activation of the force majeure clause provided for in the ARENH framework agreement, which would temporarily stop deliveries of ARENH's volumes and allow suppliers to obtain supplies on the market at a much lower price for the totality of the volumes to be delivered. EDF is opposed to the triggering of this clause, arguing that the conditions laid down in the EHNRA contract are not met. The CRE, in its Deliberation No. 2020-071 of March 26, goes in the same direction. It considers that ”the consequences of a total suspension of the ARENH contracts due to the activation of the force majeure clauses would be disproportionate. (...) such a situation would create a windfall effect for suppliers to the detriment of EDF, which would run counter to the operating principles of the system, which are based on a firm commitment by the parties over a period of one year.”
Competition and solidarity
However, independent suppliers are not totally abandoned to their fate. First of all, the smallest ones can invoke the ordinary law of this period of crisis, in this case the application of the provisions of Order No. 2020-316 of 25 March 2020, which allows micro-businesses whose activity is affected by the epidemic to benefit from a deferral or staggering of the payment of their gas and electricity bills without penalties. Secondly, in order to limit the opportunism of suppliers, the mechanism of the ARENH foresees that those who subscribe volumes higher than their customer portfolio must pay a penalty on this excess. The CRE is asking that this penalty be abolished for the year 2020, since the difference between subscriptions and sales is the result of the political decision to confine.
Finally, CRE invites EDF to grant certain suppliers whose situation justifies it additional payment facilities. This invitation highlights the somewhat contradictory situation in which EDF finds itself as a result of the ARENH: a nurturing mother waiting for suppliers to come to it (demand has always been less than 100 TWh until 2018, and even nil in 2016), a dominant company required to respect the ARENH commitments (i.e. to supply its competitors, some of whom are asking for more supply), and now a benevolent company expected to help its unfortunate competitors. But those of the suppliers who will not benefit from additional payment facilities will be able to cry out for distortion of competition.
In this period of crisis, market mechanisms do their balancing work and reveal the value placed on electricity by buyers and suppliers. The ARENH, which has been designed as an insurance mechanism against price increases, does not have this flexibility. The regulated access price amplifies the losses that suppliers incur because it is an option until they subscribe to it, but it is an obligation to withdraw megawatt-hours once subscribed. The judicial battle on the ARENH led by two supplier associations reveals the shortcomings of an administered system when it comes to managing the current demand shock. In a bearish context, the market price facilitates the sharing between producers and suppliers of losses due to the contraction of final electricity demand. The administered system cannot anticipate all eventualities, except by trying to mimic the market. But then, what is its purpose?