Energy markets need a central bank

Energy and climate policy could be implemented by an independent institution operating under the supervision of the Parliament.

In accordance with the Paris climate change protocol, the energy system of the European Union should be emission-free by the year 2050. The radical nature of the agreement has not been fully understood in Finland.

Responsibilities in the energy sector have not been defined clearly or are constantly being changed through political decision-making. The imperative and inevitable change ahead requires a new actor to take charge: a central bank for energy.

Regardless of whether the future emission-free energy source is nuclear power, fossil fuels combined with carbon capture and storage, or renewable energy sources, the importance of electricity will continue to grow. Electricity can be used to generate all other forms of energy, such as heat and fuels, and to use carbon dioxide as a source of carbon for plastic, chemicals, and medicine.

The future energy markets are therefore electricity markets, and they must be designed to function optimally. If the targets of the Paris Protocol are observed, for example the oil market will become irrelevant – it will no longer exist in 2050.

The revolution ahead is comprehensive, and the current actors do not possess the authority to see it through. An indication of this is the increased spectrum of support mechanisms for energy production.

We are at a crossroads and are faced with a decision: should we pursue a planned economy where political maneuvers plug the holes in the system, or do we choose functioning markets? The current system is heading towards a planned economy.

One step towards functioning markets would be to establish a central bank for energy. It would be an independent institution, and its operation would be governed by law. The law would define the bank's basic mission and authority. The central bank for energy would not operate directly in the energy or power markets, but would instead bear responsibility for the technical stability of the system – just like a central bank does for a monetary system.

As the Bank of Finland implements the monetary policy, the central bank for energy would implement the energy and climate policy in a manner that fulfils the obligations imposed by the EU. Similarly to the Bank of Finland, the central bank for energy could also be supervised by the Parliament.

The central bank for energy would disambiguate the division of responsibilities and eliminate political actors from practical energy production. After the arrangement, the Parliament would no longer need to enact acts on, for instance, detailed support systems for different forms of energy production – decisions would be made by the central bank for energy.

Furthermore, the central bank for energy would have other duties: it would ensure the long-term stability of energy prices, control the overall costs of energy, and implement energy-related climate targets comprehensively. The central bank for energy could regulate markets with different control mechanisms to fulfil its obligations.

The need for a Central Bank of Energy only increases as the significance of renewable energy grows.

Renewable energy will completely reshuffle the markets. If renewable energy accounts for a large share of the total energy production in the future, it will periodically result in a significant surplus of energy. Nevertheless, production cannot be restricted, let alone discontinued – otherwise the share of renewable energy would remain insufficient. This asymmetry between a surplus and consumption cannot be resolved with current market mechanisms.

In addition to production, the central bank for energy would be in charge of sufficient and timely consumption by creating suitable market mechanisms. Digitalisation and the Internet enable a real-time energy market.

Moreover, the central bank for energy would be responsible for pricing mechanisms. In the future, the price of energy will no longer be based on the market price of an oil barrel, a ton of coal, or a cubic metre of natural gas. Electricity produced by emission-free sources is free of charge or nearly so. Only the building of production capacity creates costs.

In the future, the overall costs of electricity-focused energy production will be founded on the availability of financing, financing costs, and capacity prices. We will need to rethink the formulation of the market price.

Implementing massive changes requires extraordinary measures. The changes must also extend to the structures and operations of energy production.

Further information:

Pasi Vainikka, LUT docent, VTT principal scientist, pasi.vainikka@vtt.fi, 040-5825987

The article was originally published in Finnish in the Helsingin Sanomat Vieraskynä column on February 13th 2016.