The best of both worlds: Efficient decarbonisation through energy systems integration

The current rallying cry for sector integration is important to show the direction in which decarbonisation needs to move in the energy sector. On the other hand, visions that also factor in execution typically make for success in the long run. Hence, the aim of this short piece is to combine sector integration opportunities (the vision) with some of the dilemmas inherent to sound regulatory design (the execution).

Sector integration covers a wider context, not just electricity and gas, encompassing also heating & cooling, and extending into other sectors – buildings, transportation, industry, even agriculture. Here, we focus on the parts where energy regulators have most knowledge and experience: electricity and gas.

Building on what already works …

European energy regulation has long promoted internal market integration and economic efficiency. Until now, it has been developed largely separately for electricity and gas, taking into consideration their interlinkages but not in an integral framework. This approach made sense as long as the sectors functioned mostly independently, with energy flowing from gas to electricity but not the other way round. However, this is likely to change with a further growth in renewable electricity generation.

Efficient solutions for long-distance energy transport, for tough-to-decarbonise industrial sectors and for seasonal storage of energy is where power-to-gas (or power-to-X) will play a decisive role.

Thus, regulation needs to move from a primarily sectorial approach to a more integral energy or system-use approach.

So what might this mean for the integration between electricity and gas? And how to draw on the benefits of a fully integrated market? In order to answer these questions in terms of regulatory design, three main elements can be distinguished: the design of a future hydrogen market, the incentives to promote the necessary investments to get there in an efficient way, and the regulatory treatment of the electricity – gas interfaces and energy flows.

Integrated markets, taking a cue from others …

To start with the end in sight: sector integration will necessarily lead to significantly more storage installations, including power-to-gas installations producing (increasingly green) hydrogen. While the volume of a future hydrogen market is open for debate, the need for a sound regulatory framework for a European hydrogen market is beyond dispute. As long as hydrogen is blended into natural gas networks, there is no new market design question since it is simply treated as part of the current EU gas market. However, once we start to move to pure hydrogen networks we need to address that question. The current EU gas market design with its main elements unbundling and regulated third party access has proven to be very effective. From a market design perspective, it makes no difference if the molecules floating through pipes are methane or hydrogen; the same approach can be applied. Since the EU gas market design has brought significant benefits to EU consumers, it makes sense to take its best practices and lessons learnt as a starting point. To that, relevant experiences from electricity regulation can be added, such as how to deal with distributed generation and how to provide locational signals.

A necessary preceding issue is how to provide the regulatory incentives to construct such a market in an efficient way. The amount of hydrogen is expected to go up over time, while the amount of methane will likely go down.

In the early stages, mainly industrial clusters will likely be served by hydrogen. With these projections in mind, it seems reasonable to assume that hydrogen and methane markets will coexist for some time.

In fact, with the currently available double sets of pipelines in a number of important markets, they could even function side-by-side.

This raises new questions about the most appropriate regulatory design for such a transition period. First, repurposing of existing gas pipelines is often presented as one of the ways to accommodate the transportation of significant volumes of hydrogen. In such a set-up, a closer look at the regulatory asset base of the gas transmission system operators is needed to avoid end users paying twice for the repurposed assets that may already have been depreciated.

Second, given the uncertainty about the timing and scale of such future developments, as well as the likelihood about the decline of the gas market, a more flexible regulatory approach may be needed than what is currently applied to the gas market. Here, a look at EU’s telecom regulation can be useful. The telecom framework has long needed to deal with potentially competing networks, namely copper, cable, optic fibre and mobile, with different set-ups in different geographical areas, which also changed over time. This regulatory framework requires the regulatory authority to perform a market analysis every 3-5 years in order to assess what kind of access regime is appropriate, with a consistency check at European level. This framework has proven robust throughout the significant changes the European telecom sector underwent over the last decade or more. For sure energy regulation could learn from that.

The approach to infrastructure becoming ever more important …

Specifically for energy infrastructure investment, the new possibilities offer more room for competition between various options to bring energy from production sites to consumption centres. Electricity produced by offshore wind could be brought to consumers in the form of electricity, but this may require significant, and therefore expensive, reinforcements of the electricity network.

Even cost-efficient electricity network enhancements may be constrained by planning limitations or local opposition.

Besides, a high-voltage electricity line would carry maybe 1-2 GW of power, while many gas pipelines can easily transport 20-30 GW of power equivalent, providing larger economies of scale. This raises the question whether the conversion of some of the electricity produced to hydrogen and/or synthetic methane and then transporting it through (possibly already existing) gas pipelines could not be a more efficient alternative from a societal point of view, despite the energy conversion losses.

There is no universal answer to this question, and it will need to be assessed on a case-by-case basis taking into consideration scale, location and other factors that lead to system-wide effects. To compare “like with like”, an integrated cost-benefit methodology will be needed to address the economic viability of the business case or to compare competing alternative business cases. Furthermore, the network development plans for both electricity and gas need to consider rather different feed-in locations than the traditional ones. The importance of “locational signals”, known from power markets, to incentivise investments in those locations where they minimise overall energy system cost, will likely take on a new and important meaning in the context of sector integration.

Opportunities to codify the required ways and means for achieving the necessary changes exist in the foreseen revision of the TEN-E regulation. The range of such opportunities covers putting the right governance in place to ensure a neutral approach to the benefit of society, streamlining network plans and lists of projects, and developing integral cost-benefit analysis methodologies.

Don’t ignore the tariffs …

Finally, with respect to the regulation of current interfaces between the electricity and gas systems, in particular the electricity tariffs and levies due by power-to-gas producers stand out. Since such producers are no regular end consumers of electricity, the current system may need a closer look. For starters, it would be advisable to see whether current tariff structures can be disaggregated, by identifying those system services that power-to-gas producers do not really rely on and thus may not necessarily need to contribute to, and setting separate tariff schedules for such cases.

Next to that, there may be opportunities to align more operational items between the two sectors, such as timeframes and capacity products, also with a view to balancing an energy system with more intermittent generation. Indeed, with increased power-to-gas installations, more aligned market operation rules would seem the way to go.

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To conclude, visions of a more integrated energy system are rapidly taking root in Europe. That is encouraging given the decarbonisation challenges at hand. Learning from current regulatory practices, looking at other regulated sectors for inspiration, adding a dosage or two of fresh thinking – and voila, the much-needed visionary thinking will more rapidly advance to the execution stage. It is our impression that most regulators are “on the ball”, ready to support the vision and to start working on its implementation.