Expert calls for urgent electricity pricing overhaul

Cyprus must urgently decouple renewable energy prices from volatile fossil fuel costs to ensure stability and fairness in its electricity market, according to energy systems expert and former Cyprus Energy Regulatory Authority chairman Andreas Poullikkas.

Poullikkas mentioned that Cyprus is preparing to implement the European Target Model in its electricity sector.

He described the move as “one of the most significant steps for aligning the country with EU energy policies”.

However, he warned that Cyprus’ unique circumstances — including its small market size, energy isolation, lack of interconnection with the European grid, and dependence on imported fossil fuels — pose serious challenges.

“These structural features create conditions that facilitate the abuse of market power and artificial inflation of electricity prices,” he explained.

According to Poullikkas, the recent dry-run phase of Cyprus’ electricity market reform highlighted the risk of renewables being tied to price fluctuations of conventional fuel-based generation.

“The need to decouple the prices of renewable energy sources from the volatility of conventional unit pricing is imperative if we are to avoid systemic weaknesses and foster transparency and price stability in the electricity market,” he said.

To tackle these risks, Poullikkas proposed two proven mechanisms used in mature electricity markets.

“The first is the ex-ante market power mitigation mechanism, and the second is the price shock absorber mechanism,” he stated.

He described the ex-ante market power mitigation mechanism as a method already well established in regions of the United States, including PJM, NYISO, CAISO, and ERCOT.

“The mechanism is also applied in many other countries around the world to prevent the abuse of market power before it arises,” he added. “The fundamental principle relies on default energy bids, determined based on the short-run marginal cost of production units.”

“When a submitted offer deviates beyond a predefined tolerance threshold, an automated control and correction process is triggered,” he explained.

On the price shock absorber, Poullikkas recalled that the mechanism was developed during the 2022 energy crisis, when soaring gas prices triggered extreme increases in electricity costs.

“The mechanism continuously monitors the accumulated inframarginal rent of a basket of renewable energy sources,” he said.

“When that rent reaches a multiple — typically two or three times — of the levelised fixed cost of those technologies over a given period, the mechanism is automatically activated,” he explained.

“At that point, a temporary restriction is imposed on the ability of conventional generation units to set wholesale market clearing prices, via a predefined price cap,” he continued.

He added that “the innovation of the mechanism lies in its ability to temporarily decouple electricity prices from the extremely high prices of fossil fuels, while maintaining the core function of the market.”

“Renewable energy producers receive the capped price, while conventional units that are still needed to meet demand are compensated for their higher fuel costs through a separate cost recovery mechanism,” he explained.

Poullikkas emphasised that both mechanisms apply exclusively to the day-ahead market and do not interfere with long-term contracts or bilateral agreements.

“This selective application ensures that long-term investment decisions and the development of the forward market are not obstructed,” he said.

“The forward market operates independently because long-term contracts have fixed prices that are unaffected by fluctuations in the spot market,” he added.

“This separation is crucial for preserving incentives for long-term investment and for developing effective risk management tools,” he explained.

According to Poullikkas, “power purchase agreements and other forward contracts will continue to operate based on their agreed prices, regardless of any interventions in the day-ahead market.”

“This ensures that renewable energy producers can secure stable revenues via long-term contracts while also benefiting from improved pricing in the spot market,” he said.

He said that adapting these mechanisms to the Cyprus electricity market will require some technical adjustments to the market management software but confirmed their feasibility.

“The software already has the flexibility to incorporate complex pricing structures and constraints,” he said.

“It is designed to maximise overall social welfare and can support differentiated bids by technology,” he explained.

Required modifications will include the creation of a database of default energy bids for each unit, development of algorithms for automatic monitoring and correction of bids, and tools to activate the price shock absorber when necessary.

Poullikkas added that “implementing these mechanisms in Cyprus is expected to deliver significant economic benefits.”

“Lowering electricity costs will enhance the competitiveness of Cypriot businesses and reduce household living expenses,” he said.

“This is especially critical for an economy that is both energy-isolated and reliant on imported fuels,” he noted.

“Stabilising energy prices through reduced dependence on fossil fuel price swings will create a more predictable business environment and support long-term economic growth,” he added.

What is more, the analysis stresses that regulatory changes will be required. “The introduction of these mechanisms will necessitate amendments to Cyprus’ existing electricity market rules, approved by the Cyprus Energy Regulatory Authority,” he said.

New provisions, Poullikkas explained, must be introduced for the calculation and enforcement of default energy bids, and the entire framework must ensure transparency and safeguard the rights of all market participants.

“Alignment with European law, particularly Directive 2019/944 on the internal electricity market, is essential for legality and acceptance,” he said.

“The experience of other European countries shows that these mechanisms can be applied within the existing EU framework without requiring special authorisation,” he added.

Poullikkas further pointed out that successful implementation depends on coordinated efforts from all stakeholders.

“A phased approach beginning with a pilot period will allow for the identification and resolution of technical challenges prior to full activation,” he said.

“Continuous monitoring and evaluation will ensure the mechanisms work effectively and adapt to evolving market conditions,” he concluded.