— Could you tell us about the background of market coupling in the EU? What do Europeans need this mechanism for?
— Market coupling is the evolution of explicit auctions on the interconnectors’ capacity allocation.
— Would you please clarify?
— When the European Union was established and the electric energy trade rules were formed, the countries faced two problems – ones of legal and technical nature. According to the Treaty of establishing the EU, electricity is a commodity, no barriers to trade should not actually exist. However, the issue related to the capacity of electricity transmission systems, the interconnections, was not clear. Thus, an auction mechanism appeared in the EU: it was decided that the system operator, and later the joint allocation office, JAO, will distribute all available capacity at annual and monthly auctions, aimed to hedge price risks, and to minimize imbalances at daily auctions.
The auction mechanism works as follows in the EU: companies submit their interconnections bids and if the bids volume is less than the interconnection volume, the interconnection is provided free of charge. If the bids volume is bigger than the potential interconnection volumes, the system operator rejects the cheapest bids and the interconnection access is given to the participants that are willing to pay more. However, the price for all participants will be the cheapest price from the accepted bids in order to minimize the trade barrier between countries.
In case of an interconnection demand, these funds are directed to the interconnection modernization according to the European regulation. This happened in Ukraine, when the funds from the auctions held in the new market were directed to the interconnection expansion with Slovakia.
However, our European colleagues faced the problem of daytime auctions. Prices on spot markets in Europe (day-ahead market and intraday market) are very volatile. As an example in the Czech Republic, the price fell by 200 euros in one day last year. Such price jumps deprive the company of the ability to predict trading results. Daily auctions can be held only in relation to the price indicator of the DAM. Therefore, in 2015, the EU member states approved EU Regulation 2015/1222 of the ÑÀÑÌ, which actually introduced such a concept as market coupling. The interconmnection volume began to be determined accordingly in an implicit way.
Market coupling is the solution to the problem of the most efficient organization of the trade between countries on the "day-ahead" market, which resulted in the unification of the DAMs of European countries and the formation of a pan-European spot market.
After the physical unification of the energy system of Ukraine with the energy system of Western Europe, we started working on unifying our "day-ahead" market with the European one in March of last year. We are at JSC "Market Operator" have been advocating for Ukraine to join market coupling since 2019. This is provided by the strategic plan for the development of the company, which was approved by the Cabinet of Ministers of Ukraine in 2019.
— What kind of market coupling implementation format do you consider?
— Several different associations existed in Europe until 2021. It was not one marketplace for the entire Europe. Even now, European legislation allows the formation of different zones or combinations of zones for the market coupling process. For instance, it would be possible to arrange something for Ukraine, Poland, Romania and Slovakia, call it as our small market coupling and act.
We managed to talk to all neighboring market operators, system operators and regulators in March-April of this year. The key question we asked them was: "Are we creating a separate trade zone?". Their answer was unequivocal: "There is no need to create something unique for Ukraine." I consider it to be the right approach. There is no need to make decisions that are not practiced in Europe, and then heroically correct the mistakes caused by such decisions.
In order to implement the market coupling process, the Council of Ministers of the Energy Community approved an adapted version of the CACM Regulation 1222, which also defines the entire market coupling process, in December 2022.
— What stage is the market coupling process at now?
— Not only our desire, but also the desires of European partners are necessary for market coupling to take place. Therefore, the updated EU Regulation 2015/1222 of the ÑÀÑÌ imposed an obligation on Ukraine to join, and on Europe to accept us after completing our "homework".
The discussions with the NEMO Committee (Nominated Electricity Market Operators Committee - the Committee that unites the work of all nominated market operators of European countries - ed.), with market operators, on whether Ukraine can participate in market coupling, arose immediately. This issue was resolved after colleagues from the European Commission and the Secretariat of the Energy Community gave an answer to the NEMO Committee on how this process should take place.
The implementation of EU Regulation 2015/1222 ÑÀÑÌ is the starting point. Nothing can be done without it, because we are not members of the EU, and Ukraine did not have the right to apply for participation in market coupling until the adoption of the adapted version of this document.
The new regulation required a number of actions from Ukraine. First of all, we had to notify about the existence of a legal monopoly on the conduct of auctions on the DAM and IDM by February 15, 2023.
— Did we notify?
— Yes, we did. There has been a monopoly on this type of activity in Ukraine since 2019.
— Is this «Market operator»?
— Yes, this was the position of the Verkhovna Rada of Ukraine in 2017, when the Law "On the Electric Energy Market" was adopted. There is a lot of debate going on about this issue nowadays.
But I personally do not understand why the entire process of market coupling boils down to one banal question: should we have a joint-stock company that has been organizing the work of the DAM and IDM for 4 years, which are the only debt-free segments on the market today, as the market operator, or do we need to play the game "will the debts appear in case of the appearance of several market operators on the DAM "?!
The colleagues who discuss market coupling are only interested in this issue, they don't care about anything else. The global task is to solve other issues necessary for the successful unification of the DAM of Ukraine and Europe.
For instance, no one raises the question that when implementing market coupling, the market operator - no matter whether it is a monopoly or a competitive one - will have to cover the difference between VAT in Ukraine and VAT for exports in the amount of up to 1-1.5 billion UAH per year. It is clear that this money must be returned by the state at some point, but first it must be found somewhere. It is also necessary to pay at least 100 million UAH per year to pay the excise tax on imports, to introduce negative prices, to provide a huge number of tools to ensure the fulfillment of obligations to counterparties in all European states with which Ukraine borders, to adopt pan-European rules without any changes.
— So, what steps should we take to implement market coupling?
— The Ministry of Energy, together with international stakeholders, created a Roadmap for the implementation of the EU Regulation 2015/1222 ÑÀÑÌ. It proposes amendments to the Law "On the Electric Energy Market", which predicts all urgent and operational issues arising from market coupling. Including the issue of capacity transmission’s allocation, so that the part of it that will be used for spot trading is not redistributed through Ukrenergo's daily auctions (interconnection will be sold only for long-term risk hedging instruments), but through market coupling.
The second global issue is referred to VAT, excise, customs. This is a key problem today, because taxation in Europe is different from the one in Ukraine. The Ministry of Energy has developed the relevant draft law and submitted it to the central executive authorities for approval. There still remains the question of the need to contribute money in the amount of 1-1.5 billion UAH to compensate the difference in VAT. Solving it in an obvious way, that is, setting a zero tax rate on transactions on all wholesale electricity markets, is not a good option. Since the volume of tax credit, which the state will have to return to market participants, according to the most optimistic calculations, will amount to about 10 billion UAH every month.
After the adoption of all these legislative changes and the solution of the VAT problem, it is possible to proceed to the launch of the market coupling process.
— What's wrong with taxes? How does our taxation in electricity fundamentally differ from the European one?
— First of all, it should be emphasized that this is not only a question of taxation in the power industry, but in the state as a whole. Taxpayers in Europe and Ukraine differ. For example, VAT is usually paid at the consumer level in Europe. In our case - for each sold product (MW). Another example is excise tax. It is paid by producers and importers in our country, and - by the final consumer in Europe as well.
We propose to remove the excise tax for this mechanism and argue this as follows: during the current mechanism of explicit auctions, "Ukrenergo" does not always receive the difference in prices between countries that it could have received. Traders, suppliers, exporters and importers are betting a reduced price for the crossing, because price volatility is high. They go to auctions for the sale of the intersection and buy it at a lower price, and they all do it at the same time, without coordinating. As a result, the volume of crossing fees received by "Ukrenergo" becomes smaller, than the full price difference between the countries.
We tried to calculate what would happen as if there was market coupling and at the same time importers did not pay excise tax. According to our calculations, the budget of Ukraine would receive between March 2022 and today $1 million USD of income tax of NEC "Ukrenergo" is higher, due to the fact that the fee for the crossing would be higher than it is now. Because it would constitute the price difference between the spot markets, and market participants would not include the mentioned reduction to the crossing price.
— Could you please tell us about the essence of the market coupling mechanism?
— All European market operators are united in a single work system based on a special algorithm for calculating intersection and price - EUPHEMIA. According to this algorithm, the same ranking of applications for the purchase and sale of electricity takes place for each EU country, as in our market "a day ahead", and taking into account the intersection, the results show by a complex mathematical method how much electricity can be exported or imported from one country to another.
Thanks to the fact that the crossing is distributed not in an explicit, but in an implicit way, the use of the crossing is maximized, the concentration in all markets decreases, and the monopolistic influence of companies decreases accordingly.
Consequently, competition increases, and in general, the price for the whole of Europe decreases because of the supply and demand increase, and the maximum sales volume is accepted. Because if Slovakia, for example, has large sales volumes and the Czech Republic has additional demand, then this demand and supply will necessarily converge within the framework of market coupling. This would not have happened in the case of annual or monthly auctions, as generation would not have come to the auction with such volumes, fearing price volatility.
— Do Ukrainian traders have to register on the platforms of the European DAM operators?
— No, the DAM is becoming a single market for all EU countries and Ukraine. Ukrainian companies will continue to work with JSC «Market Operator», and European companies will continue to work with their market operator. If the participants' applications are accepted, they will sell or buy electricity on the Ukrainian DAM and IDM, and JSC «Market Operator» will do the rest.
— Will Ukrainian traders no longer buy the daily interconnection?
— After the introduction of market coupling, market participants will no longer buy the interconnection from Ukrenergo at daily auctions, as they will have access to a more liquid and less risky segment - DAM or IDM.
— So to say, prices are not forecasted for tomorrow in Europe, are they?
— No, they are definitely forcasted, but this is done by players, that have the appropriate analysis and talent for it. We, as Market Operator, are also trying to forecast prices in Slovakia and Romania for tomorrow, and we even provide relevant consulting services. It is difficult, it requires understanding of those markets.
— Could you please tell us more about the flow of funds in the market coupling mechanism?
— The flow of funds will take place in accordance with the agreements between the participants of the global European market, which are system operators, nominated market operators and JAO. As part of this flow of funds, participants will receive money for electricity, and system operators will receive the difference between the prices prevailing on the DAM.
— In other words, with the market coupling’s implementation, the price for interconnection will be hidden in the price structure of applications on the DAM?
— Not quite so. If there is a difference between prices on the DAM and export/import prices, this profit is received by system operators, which, in accordance with EU Regulation 2015/1222 CACM, must use it to expand the interconnections.
— It is clear, but what about price caps, should they be canceled so that prices in Ukraine can change like in Europe?
— If we are talking about market coupling, then price caps should be the same for all participants, as the implemantation of a different level of price restrictions will put our participants at a disadvantage compared to their European counterparts.
— Which countries will participate in market coupling? The entire EU?
— Yes, and even more. These are also countries of the Energy Community and the European Economic Area.
— Will it be one common DAM for all these countries?
— Not exactly. It will be a single ranking to which all applications from all countries will be submitted. However, they will be accepted taking into account physical limitations, i.e. the availability of capacity allocation. Based on this, if there is enough capacity allocation to balance supply and demand, the price will be the same. If there is a shortage, the prices will be different.
— Prices are often higher in Poland, aren’t they?
— Undoubtedly, they are, because there is an interconnecton restriction on the border with Poland that does not allow all the surplus from other countries to be transferred to cover the need in Poland. Since it is impossible to transfer all the electricity, there appears a price difference (it becomes more expensive in Poland). And this difference, for example, between Poland and Slovakia, goes to the Slovak transmission system operator and the Polish one in half, so that they complete the networks and remove these restrictions. When they build the networks, the price difference will decrease or disappear. This is one of the ideas behind the market coupling mechanism.
