The Czech Republic’s Energy Regulatory Office and the role of regulation in crises
By Stanislav Trávníček, Chair of the Energy Regulatory Office of the Czech Republic
The Energy Regulatory Office (ERO) is the Czech Republic’s national regulatory authority, supervising the country’s energy market, which is largely characterised by a monopoly in distribution and transmission, and is also the body responsible for protecting energy consumers. But the energy crisis has revealed certain deficiencies in the market, and not only at the highest level but also in its foundations, i.e., in the relationships between consumers and suppliers, with sometimes conflicting interests. Stanislav Trávníček is the ERO Board’s Chair and has worked as an energy professional since 1998. He explains what the 2022 energy crisis meant for ERO in its role as energy regulator, from dealing with consumer complaints to identifying windfall profits.
The energy crisis in the Czech Republic
The energy crisis had its first heavy impact on the Czech market as early as the autumn of 2021. On 13 October 2021, the Bohemia Energy Group’s suppliers, which between them had been providing electricity/gas to more than 900 000 supply points, announced the end of their operations.
The culprit was gas supply cuts by Russia combined with the business strategy pursued by the whole Bohemia Energy Group, which had essentially been buying energy at spot markets only. Even the initial price increases at exchanges during the summer of 2021 therefore had fatal consequences for the Group and its customers, as it was unable to honor its obligations. Overnight, every tenth customer in the Czech market lost their energy supplier.
We can view the consequences of the Group’s collapse in terms of two aspects: security of energy supply and impact on prices. In terms of security of supply, the safety network of suppliers of last resort got into gear right away. This network consists of five companies in the Czech Republic and it passed this historical acid test. Within a few days, it had accepted all customers of the collapsed Bohemia Energy Group and started supplying them with energy without any interruption.
There was a need to immediately transfer large volumes of data between suppliers and to instruct hundreds of thousands of customers on what they needed to do. ERO also played a major role in this process. At the same time, the legislation was silent on a number of the necessary details, and these had to be worked out in urgent meetings and agreements with suppliers of last resort and other organisations, and not only energy ones. For example, it was also important for the State to activate its welfare system, for local self-governments to help their citizens, etc. Although supplier collapses had occurred previously, none of them had been so extensive and, most importantly, none of them had occurred during a turbulent situation in energy markets.
In terms of the other aspect, impact on the prices, the suppliers of last resort, by the very nature of their operations, could not have held a sufficient volume of energy to fulfil their long-term purchase contracts. Thus, they were compelled to buy energy at spot markets, which even back then were expensive. The practical result was a sudden surge in the final prices paid by those customers affected, which doubled or even tripled.
Adding insult to injury, these households and organisations were also confronted with higher prices after leaving their suppliers of last resort to migrate to standard suppliers and signing new contracts with them — for new, higher prices. As much as one tenth of the Czech market was hit, which caused a spike in prices strong enough to be felt in countrywide statistics. The growth shown by, for example, Eurostat in the period under review can be largely attributed to this development.
Record number of questions and complaints to ERO
There were record numbers of consumer questions and complaints to ERO in 2021 and 2022 — more than 22 000 each year, twice as many as in the pre-crisis years. In 2021, these were mainly about switching suppliers following the collapse of the Bohemia Energy Group suppliers. In 2022, the questions focused more on the impacts of the energy crisis, primarily price hikes or increased advances. In many cases, we addressed suppliers’ anti-consumer practices, such as their breaching firm contract prices or even unauthorised threats to disconnect consumers’ supply points.
The rising number of the problems to be handled was reflected in our supervisory activities: we received from consumers over 1 500 requests to open an investigation; this was ten times more than in the pre-crisis period. ERO initiated more than 360 sanction proceedings in response to irregularities found on the part of suppliers.
Another feature of the Czech energy market is the fact that ERO plays the role of arbitrator: we are responsible for alternative dispute resolution (ADR) between market participants, in particular between consumers and suppliers. In 2022 alone, we faced 440 applications from consumers to commence dispute proceedings — eight times as many as before the energy crisis broke out.
Our advisory services and assistance to consumers have therefore become a significant part of our everyday operation and are unlikely to decrease in the foreseeable future, despite our efforts to inform the public and prevent problems through media and training. If ERO is to honor its current and future obligations as outlined in this article, it seems likely that we will have to strengthen our human resources.
ERO’s response to supplier collapses
The pricing consequences of the collapse of Bohemia Energy and other suppliers sparked tempestuous society-wide debates in the Czech Republic about the supervision of suppliers and about how the liberalised energy market should actually work. As regulator, we were being accused of insufficient supervision, even though we did not (and still do not) have any powers under national or EU law to oversee or, especially, to interfere with suppliers’ business strategies in terms of their own energy arrangements. Quite on the contrary: laws have been geared towards promoting competition and minimising the obstacles to business in the energy industries.
Responding to society-wide demand, we have drawn up proposals for certain amendments to the legislation, intended to prevent such problems going forward. However, it is important to note that ERO has no law-making powers. In addition, the necessary amendments cannot be enacted through delegated legislation, i.e. public notices — read regulations — that ERO is authorised to promulgate. Certain provisions of the Energy Act would have to be changed.
Our proposals put forward several alternative options, ranging from mandatory to discretionary measures. As regards suppliers’ own energy arrangements, we proposed, for example, obligatory procurement of energy under long-term energy purchase contracts in cases where the suppliers have long-term contracts with their customers. However, this proposal also has its downside. Logically, it would narrow suppliers’ room for maneuver in business terms, thereby considerably offsetting the benefits of competition, which generates different and ultimately lower prices for final customers thanks precisely to suppliers’ diverse business strategies.
This is one reason why ERO was quite inclined towards an alternative proposal under which suppliers would publish an index of their energy provisions. This would offer consumers a transparent tool to help them assess the risk faced by their suppliers and give them an opportunity to freely decide whether the risk is commensurate with the quoted price.
One important proposal was to ‘stigmatise’ suppliers that had failed to honour their obligations in the past, thereby barring them from re-entering the industry and forcing their customers to migrate to suppliers of last resort. Although the current liberal approach helps to expand the group of competing entities, it does so at the cost of exposing consumers to a disproportionate risk arising from suppliers that engage in moral hazard, to say the least.
Crisis and transition: impacts on grid operation
Last year, the price hikes in energy markets were also reflected in the costs of operating energy systems. As early as mid-2022, ERO therefore warned that reducing the impact on final customers in 2023 was contingent on subsidising certain regulated costs. These specifically included the cost of covering losses for distributors in the electricity grid and the gas system and the cost of ensuring balance in the electricity transmission system.
The energy required for ensuring system operation is bought from the free market. According to preliminary calculations, Czech customers would therefore have to pay €1.5 billion more in 2023 than in 2022 in the electricity sector, and €0.1 billion more in the gas sector to cover the regulated component of prices. The country managed to prevent this only thanks to intensive talks between ERO, the Czech government and energy distribution and transmission companies. The Czech government decided to reimburse these increased costs from the national budget. Otherwise, the increase in the regulated component of energy prices’ would have negated the benefits for consumers of the previously announced capping of the unregulated component of energy prices (formed on the free market), which was aimed at alleviating the impact of the energy crisis. In the Czech Republic, both the regulated and unregulated components of electricity and gas prices have thus de facto been capped.
However, it should be borne in mind that over the long term, the costs of operating the energy system are most likely to increase, owing to the ongoing energy transition, which primarily consists of decentralising generation. Although this process is inevitable, from the perspective of enhancing the Czech Republic’s and whole EU’s independence from non-European fuel suppliers, above all ‘unknowable Russia’, its financial impact also has to be addressed. A scheme for subsidising network operators must be implemented in addition to promoting the rollout of actual decentralised generating capacities to prevent customers from having to bear the burden of increased costs alone. For the Czech Republic alone, we are talking many billions of euros over several years.
The heavier demands on the increasingly complicated control and reinforcement of the electricity grid are obvious even today. The information provided by distribution system operators suggests that this year alone, some 75 000 new generating plants with a total capacity of more than 5 GW are to be connected. This is an explosive increase resulting in, for example, local system congestion: even now, new plants cannot be connected in some localities, or can only be connected at the cost of having to constrain overflows into the grid. This is certainly not desirable if we want to use decentralised electricity generation efficiently. At the same time, various individual network reinforcements in some places will require more than €1 billion in the short term. The rapid growth in the connection of these plants will also require an overall remodelling of the electricity grid. So far, the grid has been built for ‘one-way’ electricity flows from higher to lower voltage levels, from central generators to customers.
At ERO we consider community energy development to be crucial in the context of energy self-sufficiency. But this is also contingent on forthcoming amendments to the Energy Act, which currently does not cover energy storage (important for grid flexibility) or allow electricity sharing — the cornerstone of community energy. By amending the electricity market rules and allowing the sharing of electricity from shared generating plants in residential buildings, we have thus removed the barrier preventing the growth of rooftop photovoltaic systems on residential buildings, unlike on detached houses, where there has been dramatic development in recent years. However, there are limits to what delegated legislation can achieve — more fundamental changes require amendments to the primary legislation, the Energy Act.
Compensation for suppliers and collecting surplus revenues from generators
In connection with the financial impact of the energy crisis, the Czech regulator has recently been vested with powers concerning compensation for suppliers (granted due to the capping of energy prices for final customers) and the collection of surplus revenues — akin to a tax on windfall profits — from electricity generators.
Under the Czech government’s order, ERO sets compensation for energy suppliers at the level of actual costs or benchmark prices. By available estimates, full-year compensation will total some €8 billion and will be paid through the market operator from the national budget unless the ERO finds a mistake in the request. The exact amount will depend on actual prices on the energy markets.
Until now, ERO, as regulator, has not had any opportunity to scrutinise or interfere with energy suppliers’ business strategies. The above powers therefore constitute a fundamental expansion of our remit. The government’s order must be implemented in practice expeditiously, so the whole mechanism must be put in place in an extremely short timeframe of just a few months. This is all in addition to our current — already swelling — agenda.
The situation of collecting surplus revenues from energy generators is similar. The Czech government has capped market revenues from electricity sale depending on the generating technology. Where market revenues exceed the cap, the generator must pay 90% of the difference to the state. These payments will be made on a monthly basis throughout 2023, with some €3 billion expected to be collected in this manner. As in the case of compensation for suppliers, generators’ selling prices have historically not been regulated or supervised, while the collection scheme is basically akin to taxation, with which ERO has no practical experience at all. This is one reason why we will cooperate with the tax administration on technical arrangements for collection.
Gas supply in 2022
The energy crisis has impacted heavily on energy prices in the Czech Republic — as early as the end of 2021, the gas price on the market operator’s within-day market was close to €180/MWh and exceeded €300/MWh in August 2022. However, there was more than just a price shock was at play. It became increasingly obvious during 2022 that the gas supply itself could be at risk due to Russia’s systematic weaponisation of the entire industry. Ensuring gas supply was not a task for ERO directly, but as regulator our mission was to amend our delegated legislation so as to allow and motivate market participants to swiftly fill gas storage facilities, which had been only 15% full at the end of winter 2021/2022.
In 2022, ERO amended the gas market rules twice. One unplanned amendment during the year was intended to stabilise the gas sector and help to fill storage facilities thanks to new rules on auctions for unused storage capacity, based on the ‘use it or lose it’ principle newly embedded in the law. The key issue in the Czech context was the situation of the storage facility leased by Gazprom, which — rather conveniently — that company had not filled before the preceding winter while blocking its use by other traders until mid-2022, when new legislative measures took effect.
The change in the gas market rules to reduce the financial collateral required of traders, who at that time were acutely endangered by the cash flow bottlenecks caused by extreme price hikes, was also very important; as were the extended opportunities to transfer stored gas to new entities, including the State Strategic Reserves Administration (Státní správa hmotných rezerv). In late 2022, another amendment to the gas market rules implemented tools allowing international assistance in crisis situations in the gas industry. At national level, this amendment put in place new rules governing how suppliers of last resort operate.
We also changed our price decision in relation to the filling of gas storage facilities. This decision introduced a 100% discount on gas transmission from and to storage facilities, thereby reducing the cost of adding more gas to the stores. Another change concerned the search for alternatives to natural gas, specifically the extended use of biomethane. Here we laid down the algorithm for calculating the value of the withdrawal gas pipelines running from biomethane plants upon their acquisition by distributors.
These measures taken by the Czech government and ERO resulted in Czech storage facilities being filled to 100% of their capacity before winter 2022/2023, and can thus be regarded as highly successful.
Energy market evolution
In its proposal (as it currently stands, under public consultation in February 2023), the European Commission reflects on reforming the design of the energy market, focusing on generation contracts and long-term energy supply. So far, the EU energy market has relied on short-term contracts to a considerable extent, but in the future, contracts for difference or power purchase agreements, for example, could or should play a greater role.
Although such proposals appear to be logical in light of the EU market’s experience in 2022, caused by Russian aggression on the energy battlefield, from our position as regulator would point out the potential shortcomings of this approach. Essentially, our view is that the proposals are born of impulsiveness and a short-term swing in the liberalised market, for geopolitical rather than energy reasons.
Making the EU’s single energy market more resilient to external factors is certainly desirable. But diversifying energy mineral imports is much more likely to contribute to this aim than radically transforming the whole market, the foundations of which have been built for decades. If opinions are emerging suggesting that the market itself has failed, we have to investigate whether or not it really has failed and, if so, what the causes were.
The following, for instance, can be regarded as a negative aspect. The market’s design, combined with many governments’ subsidy policies and — equally importantly — with Russia’s export policy (low prices for exported gas), had pushed electricity market prices down to a level where it was not really rational to invest in new generating capacities that would adequately replace those approaching obsolescence in technical and thus also in emissions terms. However, it should be noted that this was the market’s response to the biased price signals that were being ‘covertly pushed’ onto it.
The market stands accused of another failure in relation to last year’s exorbitant prices at energy exchanges; initially natural gas prices, to which electricity prices are tied through the gas-fired power stations at the end of the order of merit. However, it is appropriate to ask whether, on the contrary, the market in fact behaved rationally and ultimately helped to tackle the situation proactively. It tackled the imminent energy shortages, the potential excess demand, and the pricing mechanism using price hikes. This helped to reduce demand. In other words, the market motivated customers and governments to take radical austerity measures which, together with the mild winter, have helped Europe to see a wartime winter through with a relative abundance of energy.
Several proposals were discussed in the Czech Republic, too, in the wake of the supplier collapses. They included proposals to require suppliers to procure 100% of the energy they would need under their long-term supply contracts with customers. Gradually, as the situation calmed down, we kept adjusting our proposals to the market reality, based on the principle of preserving a competitive environment. This is because competition is, at least now, the only means of reducing prices for final customers (leaving aside ad hoc government intervention for the purposes of this article). That is why suggested, for example, the above-mentioned index of suppliers’ energy provisions, which would serve as ‘soft’ regulation, as opposed to ‘hard’ regulation in the form of an obligation on suppliers to procure energy.
In the Czech Republic, the results of the (still voluntarily) equalisation of procurement strategies show, even now, that strict control of suppliers’ business strategies is not necessarily desirable. Last year, a large part of our country’s energy suppliers secured an abnormally large portion of their own provisions for energy supply via long-term purchase contracts. In one respect, this move may have been rational — the need to protect themselves and their customers against an extremely volatile market. However, in other ways it was a consequence of the irrational panic triggered by the previous collapse of a large supplier. What we are seeing now is energy prices falling at wholesale markets, but this fall will only very gradually be reflected in the price lists for Czech households and organisations, because the country’s suppliers have been left with only minimal room for spot transactions.
In early 2022, ERO called for this problem, which at the time was still basically just a national one, to be tackled in a cool-headed manner. Our recommendation holds even truer for EU-wide measures. The objective must be to introduce changes for the long term, and to refrain from basing such changes on a single extraordinary event.
This article was first published on the 1/2023 issue of the ECA Journal. The contents of the interviews and the articles are the sole responsibility of the interviewees and authors and do not necessarily reflect the opinion of the European Court of Auditors.
