European interconnection industry I

This article is the first in a series of four covering the expanding market for electrical interconnections in Europe. It sets the scene by presenting the main points and current developments around the difficulties linked to building and financing these assets. Future articles will be covering the example of a privately-financed interconnector (Eleclink), the public incentives to foster investments in interconnectors and the role of JAO, the Joint Allocation Operator.

The development of interconnections has been flagged as a priority investment by the European Commission in its ambitious push to develop renewables. The revised Trans-European Networks for Energy (TEN-E) policy has identified three priority corridors where new projects can benefit from funds from the Connecting Europe Facility. As the 2024 ten-year network development plan of ENTSOE is under preparation, an examination of the economics and regulation of interconnectors seems appropriate.

Interconnectors are more than just electrical cables connecting the national transmission grids of European countries. They are the narrow corridors through which excess supply or demand in a country can be transferred to another market, providing energy security and price flexibility to customers. As illustrated during the winter of 2022, which combined low availability from the French nuclear fleet due to corrosion issues and an unprecedented gas shortage due to the invasion of Ukraine by Russia, the ability to pool electrical resources at a continental scale has been instrumental in the avoidance of a generalised blackout. Building new interconnections is a critical step in achieving both the integration of European energy markets and the energy transition. 

Interconnectors have become a vital part of the European electricity system

Historically, European countries have developed their electricity grids on a national basis, with each country’s utilities building the networks of the areas they were tasked to manage and operating them in a vertically integrated fashion (i.e. combining production, transportation, distribution and commercialisation). Through a series of directives and regulations known as the energy packages, the European Commission has progressively opened the markets to competition and split the various roles between different companies. Regarding the transportation networks, TSOs (Transmission System Operators) are the independent actors tasked with the management and development of the grid. They notably are responsible for the building and reinforcement of interconnections.

These interconnectors provide a form of resilience to European countries as they can rely on the production of other countries, should they encounter difficulties on their own market. For example, during 2022, French nuclear production has been down by 30% compared to the average of the last 20 years with up to 65% of the nuclear fleet shut down during the summer. This was combined with a record low level of hydroelectricity production, actually the lowest level of production since 1976 due to record heats. As a result, according to RTE, the French TSO, in 2022 France was a net importer of electricity for the first time since 1980 with a net negative balance of 16.5 TWh, 4% of the national electricity consumption.

To further highlight the importance of these interconnections when it comes to security of supply, two incidents are worth mentioning. Although not directly between two countries, the Conneforde-Dile powerline crossing above the Ems river in Germany is linking two distinct TSOs, E.On Netz and RWE TSO. In 2006, a routine disconnection of the cable to let a ship sail underneath the line triggered a massive blackout that spanned across Europe, depriving millions of households and businesses of power. Further back in 2003, a massive blackout affecting up to 56 million people mostly in Italy was triggered when trees fell on an interconnector between Italy and Switzerland.

Interconnectors are the backbone of the European electricity market

European wholesale electricity markets are increasingly integrated, thanks to the coupling provided by interconnectors. They allow electricity to flow from a market with excess supply to a market with excess demand, which in turn pushes toward an alignment of prices between countries. Each international transaction on wholesale markets entails the allocation of an associated “right of passage” on an interconnector. The flows are then only limited by the capacity of the interconnectors at any given point in time. For example, on January, 3rd 2024, a record 20.3 GW of capacity was booked for exports on interconnectors linking France to its neighbouring countries (this is equivalent to the capacity of more than 12 EPR nuclear reactors). 

The availability of interconnectors is thus the limiting factor in the integration of European markets. This leads to consequences both in terms of capacity allocation for the standard operations of markets and to a renewed drive for investments in additional assets. 

For standard operations, interconnection capacity has to be booked based on an auction process that is centrally managed for most assets by JAO (Joint Allocation Operator). JAO is a platform that runs more than 20,000 auctions per year on behalf of 47 TSOs, allocating capacity on various time horizons (intraday, daily, weekly,…) for electricity traders to send electricity across borders. This way scarcity is priced and managed and capacity is allocated to the transactions that have the highest economic value, i.e. those that respond to the most significant divergences between supply and demand in Europe.

This scarcity management is however deeply challenged by the coming evolution of the European energy market. The exponential increase in renewable energy production and increasing instability in fossil fuel supply due to geopolitical concern translate into a rise in intermittency in power generation. A way to manage this intermittency is to spread it over as many consumers as possible to benefit from a statistical smoothing effect. As power production diminishes in some parts of Europe because of a weather event for example, it increases over others and demand can also respond in other parts, all effects balancing each others out. This, however, requires very significant investments in transmission lines at the national level and in interconnection capacities: European electricity markets need to be able to send solar production from Spain and Italy to the Netherlands and Denmark, should offshore wind production in the North Sea diminish. This is why the development of interconnectors is at the centre of current European and national efforts to reform electricity markets. 

Source: author research based ENTSO 2010, 2020 and 2022 Ten Year Network Development Plans (TYNDP)

Interconnectors are extremely complex and expensive to build

Interconnectors are direct current cables that connect two substations on each side of the border. This requires significant network planning by the two neighbouring TSOs as connecting additional capacity to the network can create congestions downstream and may necessitate to reinforce other parts of the network. For example, the recently opened Viking link interconnector between Denmark and the United Kingdom has 1,400 MW nominal capacity but can currently only offer up to 800 MW of capacity because the Danish TSO needs to reinforce the network that spans all the way to Germany to avoid congestions. These assets cannot be improvised and are part of a complex system that needs optimisation and (costly) additional investments to accommodate them.

The cables themselves can be extremely expensive to build as a significant number of European borders are determined by geographical obstacles such as mountains, rivers or seas. Crossing these obstacles require massive investments, leading to high costs and delays in completion: high altitude interconnectors will typically need to be buried to avoid ice and wind damage, subsea cables will have to be lain on the seafloor and trenches have to be dug on the shores… As the easiest projects are built first, new interconnectors tend to be more complex and expensive.

Source: author research based on company websites, TSOs, regulators, ENTSOE and specialised news outlets

On average, a new interconnector takes roughly 9 years to bring to completion, from the initial studies to the beginning of commercial operations and costs more than €900M. This average is deeply affected by the complexity of the upstream permitting process that has to be completed on both sides of the border and that can lead to significant slippages in timetables, as Brexit notably illustrated. 

Providing incentives for the construction of new interconnectors

Building an interconnector requires the deployment of a complex contractual and regulatory infrastructure between the two countries that are going to be linked and the mobilisation of important financial resources. Typically, a Joint Venture company held at 50:50 by both TSOs involved is created. It will raise equity from the TSOs and debt from banking institutions and pursue all necessary applications and permitting required for the project to take place (environmental, social, land use, risk assessment, cost-benefit analysis…). The interconnector will then be compensated through a mix of public and private resources including public tariffs and incentives, congestion revenues generated through auctioning and remuneration for capacity and ancillary services. 

Public authorities both at national and European levels are however confronted with a significant issue: TSOs have a finite capacity to invest in such infrastructures when they also have to strengthen their own networks to accommodate for the increasing penetration of renewable energy, notably offshore wind parks. Private investors have thus been incentivised to contribute to the financing in hybrid schemes involving both TSOs and third parties or to directly propose and invest in new assets. This is the reason why European Regulation 2019/943 (art. 63) provides an exemption status that allows private actors to build, own and operate interconnectors. One such example is the Eleclink interconnector that runs through the Channel Tunnel between France and the United Kingdom. It is to be noted that these private ventures cannot however benefit from public tariffs and have to derive their revenues from their users. At least seven interconnectors with third-party investors (either fully private or in a hybrid structure partnering private investors and TSOs) have been built or are under development since the beginning of the 2020s.

Given the high level of uncertainty surrounding the initial permitting phases and the construction risk that is inherent to complex infrastructure projects, finding a financial structure that is robust enough to accommodate these levels of risks and that is profitable enough for investors is probably the main challenge on the way to developing more assets. This is where the Connecting Europe Facility comes in, providing grants to selected Projects of Common Interest (PCI) that ease the financial burden on equity investors. The European Investment Bank has also been instrumental in providing debt financing to these assets; its presence in the banking syndicate provides reassurances to other lenders. For example, it has recently provided financing to Greenlink, NeuConnect and Celtic interconnectors among others.

Emerging trends

New trends are emerging on the interconnectors market with long (multiple hundreds of kilometres), offshore assets being increasingly considered. Two factors are driving this development. First, the rising presence of offshore wind parks creates the need for offshore cables and thus also an incentive to mutualise assets with interconnectors by creating dual-use cables. Second, there is a drive to connect areas outside of Europe, notably in North Africa and the Middle East, that have access to significant renewable energy potential, most notably solar energy. For example, Xlinks is an interconnector project that would link Morocco and the United Kingdom, Elmed will link Italy and Tunisia and EuroAfrica would link Greece, Cyprus and Egypt.