Market coupling and the liquidity question

Market coupling: an introduction

The single trading floor

In recent years, the management of geographical constraints in the intraday trading world has increased in efficiency; we have arrived at a place where an energy bid from Poland is matched with an opposing bid from Portugal. The fact that this is possible and works as well as it does is attributable to a complex background process that often goes uncredited because the market has become so used to cross-border transactions. The apparatus behind the scenes, so to speak, is referred to as market coupling. Given the number of participating countries, the system is remarkably robust, with hardly any outages occurring. In the event of a potential decoupling of markets, an automatic fallback on local markets is in place to ensure electricity supply without end consumers noticing. For example, if Germany offers energy at a lower cost than France, the latter can opt to import electricity from the former and vice versa. This structure in its entirety essentially acts as one unified virtual trading floor. It is the realization of a single market for electricity.

Handbook of European Electricity Market Coupling: Chapter 14 - Market Perspective

Why market coupling matters, especially for intraday

With market coupling, Europe has one of the biggest internal power markets on the global scale. This in itself is quite an achievement, but the story does not end there. Market coupling also allows new companies with innovative technologies to find traction in the European arena. The magnitude of algorithmic trades has risen tremendously within the last years, which creates a lot of liquidity and makes the market more efficient. Of course, market coupling cannot replace the technology needed for this, but it makes it possible for the technology to be converted into use cases. Contrary to popular belief, it is not a coincidence that the rollout of AI trading and market coupling, especially for intraday, happened at the same time – they are mutually dependent.

Consulting the statistics of social welfare gains, which are vital for reaching the intraday market coupling end goal of jointly securing supply for the population with the limited resources available, the question arises whether these gains were achieved only due to an increased trading efficiency. One of the biggest advantages of market coupling is that it lowers market entrance barriers dramatically, which is of paramount importance for geographical expansion and serves as the backbone of automated trading in the system. Once a company is active in one market, the pathway to the next market within the coupled area is cut in half.

Why are we so keen on cross-border data?

Our world runs on data – the energy business is no exception. Accurate data analysis is key for any successful enterprise, and market coupling brings several advantages in this regard as information extracted from one market can also be applied to others. For instance, an outage of a big power plant in France does not only impact the French power ecosystem but that of other bidding zones as well. Through market coupling, the same data can be considered for all use cases, which reduces workload significantly. However, this only applies if enough physical capacity remains for a particular hour at a particular point in time. Real-time data provision is crucial for evaluating the effects of fundamental data on the internal market and being able to act on them. Insight into open market data lowers the barriers for exploring trading strategies and validating business ventures.

Why do we innovate in algorithmic trading?

With the onset of market coupling emerged a common forum where TSOs, NEMOs, regulators and market participants can work together. Despite the different interests of these parties, workflows were established in a coordinated manner so that data provision is aligned, which in turn creates pressure to publish the right information at the right time. When it comes to data transparency, there is still room for improvement, but the progress made in that direction cannot be ignored.

The question now is whether market coupling has trading benefits other than a simple increase in trading. In short, yes! A well-functioning wholesale market opens many opportunities for trading – in particular with the help of algorithmic trading. According to numbers from EPEX SPOT, Germany saw a 73%-share of algorithmic trading in 2022, up from 56% in 2020. Growth rates are similar in other coupled markets, which establishes an ideal foundation for capturing flexibility and unleashing its full monetary potential. Without market coupling, the liquidity of the order book would be lower, and assets would earn a much smaller profit. Such developments can be observed in less developed markets. After the closure of the SIDC order book, locally available orders are no longer providing adequate liquidity. And that is not all. The environmental implications could be dire as well. It is a chain reaction. Less flexibility in the market means fewer renewables and more grid instabilities. Why? Because even with a smaller ratio of renewables, flexibility is needed to balance them out and avoid fluctuations in the power supply. Market coupling multiplies the availability of flexible sources by unprecedented levels. 

API traded volumes share calculated as a percentage of traded volume (sell+buy) originating from orders
submitted by EPEX SPOT M7 API | Source: © EPEX SPOT - 2023 all rights reserved

Why is liquidity vital for our market activities?

Liquidity ensures the ability to buy and sell products without having to pay significant spreads, which secures a robust service and solid supply to customers. Algorithmic trading generates liquidity but also requires it to develop. Algorithms increase speed and responsiveness to changes in the order book and fundamental data. This is especially crucial when prices move quickly. Algorithms provide liquidity where it is needed: at the top of the continuous trading order book, which eventually leads to a reduction in price volatility. The rising churn rates in coupled markets are unmistakable indicators of increasing liquidity.

Source: Wholesale Electricity Market Monitoring 2021 by ACER

In markets with low liquidity and a rather static order book, large orders are needed to increase transaction volumes. Little trading activity creates a market situation in which algorithmic strategies have no significant advantage over a manual approach. Algorithms are most effective when they can leverage trading opportunities arising from a dynamic market environment. A rationally behaving order book is the feeding ground for algorithmic profit exploitation. Paradoxically, liquidity constitutes a major prerequisite for putting effective algorithms in place. This causality dilemma, more commonly known as a chicken-and-egg problem, was solved by the coupling of markets as it kickstarted a liquidity upward spiral of sorts, allowing neighboring countries to profit from each other’s liquidity.

How do we create new business opportunities?

How do we keep innovation afloat throughout the ongoing rise of intraday volume and API*-based trading? It appears that the low-hanging fruits, mostly coming from the supply side, have been picked. Generators have put intelligence aplenty into the market design. The demand side, too, is experiencing an upswing as price pressure rises. Unleashing demand-side flexibility will continue to overhaul regulating policies, resulting in more opportunities to profit from flexibility.
*API - Application Programming Interface

This brings forth many new business models. With the massive investments in batteries, which are necessary to reach climate goals, market coupling directly aids trading volumes on the wholesale market. At enspired, we observe the explosive demand for combined battery storage marketing offers (covering both wholesale and ancillary services) on a daily basis. To reach the best commercial performance for a battery, we optimize the proportions of wholesale markets and frequency services based on price forecasts and record-speed backtesting. Battery energy storage systems (BESS) are indispensable for the energy transition, not least because they ease price volatility. According to the International Energy Agency (IEA), we need a whopping 3,100 GW of global battery storage capacity to keep global warming below 2 degrees.

Source: Net Zero by 2050 - A Roadmap for the Global Energy Sector by IEA

For future business cases, the commercial optimization of batteries is crucial. Trading strategies must maximize battery revenue by reaching a balance between asset profitability and asset lifetime. A safe approach is to prolong battery life, but when prices are extremely high or low, profits can exceed the cost of shortening the lifespan. Batteries bring grid stability, and active SoC (State of Charge) management ensures a well-functioning market.

Imagine a market where liquidity is so low that trading possibilities cannot be secured. This would result in a massive risk buffer and negatively impact the profitability of storage systems. Algorithmic trading would become next to impossible at this point. The commercial rollout of batteries would be stalled or limited by the capacity of frequency maintenance markets. That is why well-functioning coupled markets are so important – they give the right incentives to integrate more technologies that foster a carbon-free power supply.

Would all this be possible without market coupling?

In short, the answer is once again yes. BUT: Not to the extent we have now. From a geographical viewpoint, the same data and the same use cases have different footings, different potentials and different outcomes in different bidding zones. Market coupling gives assets larger areas for profitability.

With all this in mind, it is necessary to keep making strides in common projects by enhancing transparency and working more closely with the actual market users. From an outside perspective, market coupling is a very basic arrangement no one really takes notice of. In reality, it is the headquarters of innovative new business models that turn the energy market into a facilitator for a greener world.

Interested in more facets of market coupling? Chapters 1-13 cover:

• Framework of Market Coupling
• Principles of Market Coupling
• Capacity Calculation
• Day-ahead Flow-based Capacity Calculation in CCR Nordic
• Role of TSOs in European Market Coupling Operations
• Role of RCCs in European Market Coupling Operations
• Day-ahead Market Coupling Algorithm
• Intraday Market Coupling Algorithm
• Cross-zonal Shipping and Nomination
• Local Clearing and Settlement
• Congestion Income Distribution
• Role of National Regulatory Authorities in Market Coupling
• Third Country‘s Perspective on Market Coupling

Browse the complete handbook here.

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