By Dr. Andreas Poullikkas, Professor of Energy Systems, Frederick University

The launch of the competitive electricity market in Cyprus represents a significant step toward modernizing the energy sector; however, it is not sufficient on its own to ensure fair prices and smooth market operation. In an emerging electricity market like Cyprus, characterized by a dominant producer, targeted regulatory rules are essential to prevent new distortions rather than merely fostering superficial competition.

The Cyprus Energy Regulatory Authority (CERA) has already established the general framework for avoiding cross-subsidization and regulatory cost recovery through Regulatory Decision 01/2021 (KDP 359/2021), titled "Statement of Regulatory Practice and Electricity Tariff Methodology." Tariffs and charges are regulated to reflect service delivery costs, protect consumers, and prevent the distortion of competition. Nevertheless, further specialization is required regarding the prices offered by the dominant producer in the Day-Ahead Market and the management of "must-run" (mandatorily dispatched) units.

A primary issue requiring regulation is the pricing submitted by the dominant producer in the Day-Ahead Market. As long as the Electricity Authority of Cyprus (EAC) production activity maintains a dominant position, its offers cannot be treated as if they originate from a fully competitive and mature market. For this reason, a clear methodology for cost-based bidding (regulated offers) should have been established during the third trial period. This would ensure that the dominant producer's prices reflect actual variable costs, technical constraints, and reasonable cost-recovery needs, without allowing cost shifting from the forward market—specifically, from the regulated wholesale tariff.

The same principle applies to must-run units. These units are not dispatched because they are always the cheapest, but because the electrical system requires reliability, inertia, reserves, and technical operational security. Consequently, during the third trial period, their compensation for the dominant producer should have been governed by transparent rules, prohibiting cost transfers from the regulated wholesale tariff or opaque recovery through the market.

Simultaneously, it is necessary to apply an ex-post physical allocation of must-run units to suppliers prior to financial settlement. This approach is critical because must-run units provide a tangible physical service to the system; therefore, the associated energy and costs must not be allocated in a way that retrospectively alters the competitive positions of suppliers. Without prior ex-post physical allocation, there is a serious risk that reliability costs could be opaquely converted into commercial settlement elements, creating unfair burdens.

This is the core regulatory objective: to prevent the cross-subsidization of the dominant producer's allowed revenues between the regulated wholesale tariff, Day-Ahead Market bids, and the Balancing Market. If part of the dominant producer's costs is recovered through regulated charges and another part through Day-Ahead Market offers or must-run compensation without clear regulatory separation, the result will not be a market, but a distorted revenue recovery mechanism. It must be ensured that each cost is recovered only once, through the correct mechanism, and with transparency for all participants.

Regulatory Decision 01/2021 is already based on the principle that tariffs must reflect costs and avoid cross-subsidization. Therefore, the goal is not to establish something entirely new, but to specify how this general framework will apply to the dominant producer in the Day-Ahead Market and for must-run units. This is precisely how electricity markets have historically opened in many countries, particularly within the EU—gradually, with clear rules, unbundling of activities, regulatory oversight, and a careful transition from monopoly to competition. This approach aligns with our previous proposals for two specific mechanisms in the Cypriot market: (a) an ex-ante market power mitigation mechanism and (b) a price shock absorber. Regulating the dominant producer's bids and must-run units is a logical continuation of ensuring a market that operates with transparency, market power control, and consumer protection.

The need for this regulation also addresses a common misconception in public discourse: the idea that increasing Renewable Energy Sources (RES) automatically leads to lower electricity prices. This view is overly simplistic, as it considers only the generation cost of a single technology rather than the total cost of operating a reliable power system. While RES may reduce costs in the long run, they must be accompanied by sufficient investments in flexibility, storage, grids, electrical interconnections, and appropriate market regulation that fairly distributes the cost of system reliability.

In other words, the correct debate is not whether RES are "cheap" or "expensive" in isolation, but whether the power system as a whole can remain reliable and economically fair as the share of variable energy sources increases. In a non-interconnected system like that of Cyprus, this need is even more acute, as security of supply cannot easily rely on neighboring markets.

Consequently, the regulation of prices submitted by the dominant producer in the Day-Ahead Market, the separate and transparent compensation for must-run units, and the ex-post physical allocation of those units prior to settlement are not mere technical details. They are fundamental prerequisites for an electricity market to function with transparency, protect competition, and pass the true benefits of a well-designed energy transition on to consumers.

Source: Brief