Market Design

With the Energiewende the current electricity market comes to its limits. In future it will also have to provide security of supply and investment incentives.

The Energiewende implies a new design for Germany’s electricity market. The 1998 liberalized energy market deals exclusively with volumes of electricity; this is why it is often referred to as “energy-only” market. It is undisputed that the energy-only market will ensure that the cheapest power plants satisfy a given demand. Controversial however is whether the existing electricity market’s signals generate sufficient investment – both for new conventional power plants as well as for new renewable energy plants, such as wind turbines or photovoltaic systems.

In order to ensure security of supply in the few hours of peak load, sufficient capacity must always be available. This can be non-fluctuating renewable energies, fossil backup capacity, power storage, and sliding loads. There is an intense debate among economists whether the existing energy-only markets are capable of ensuring security of supply. In other words, will energy-only markets always have access to enough power to meet peak-load electricity demand? In many countries and regions with liberalized markets (such as on the east coast of the United States, Brazil, Spain, Great Britain, Russia, and South Korea), electricity market regulators have introduced additional tools to ensure reserve capacity, such as a capacity market. The reason is that supply security is a public good that benefits all electricity users. However, there is a high risk that the energy-only market cannot ensure an adequate security of supply.

The Energiewende exacerbates this issue: Even with ever increasing amounts of renewable energy Germany will require almost as many fossil fuel plants as we have today in order to compensate for low-wind and sun-deficient hours (for example, during winters) and to meet demand. However, many of these plants will operate only a few hours a year. Moreover, the question of necessary capacity to ensure security of supply in Germany has a special relevance. From 2015 to 2022 all of the remaining nuclear capacity will be phased out, relieving the system of twelve gigawatts (GW) of capacity. And most of that capacity (8 GW) will go offline in a very short period, namely from 2020 to 2022.

In addition, there is the question of whether the energy-only market will ever be in a position to refinance wind power and solar power, even if their total costs are below those of coal or gas power plants. For the problem of wind power and photovoltaic systems, based as they are on the marginal-cost-determined spot market, is that they price themselves out of the market. When the wind blows and the sun shines, all the wind and PV systems within the same weather zone produce electricity at the same time. Once a certain number of wind turbines and PV systems are in the system, this impacts the price on the electricity market. Thus, when the wind blows and/or the sun shines, a lot of power is available with a marginal cost of zero, the market price decreases because power plants with more expensive marginal cost won’t be needed and power plants with lower marginal costs will determine the market price (the so-called merit-order effect). As a consequence, wind and solar power cannot refinance themselves on today’s break-even market.

In this context, Agora Energiewende is addressing the question of how an “Energiewende market” could look like. The task of a new Energiewende market must be to simultaneously enable existing power plants to operate cost efficiently and to create incentives for the necessary investments to ensure security of supply. Moreover, it has to foster the continued expansion of renewable energy according to the existing Energiewende targets.

Contact

Core results

  1. 1

    In the PENTA region, effects from differences between national regulatory environments for the cost of renewables projects are significant and can even be larger than cost effects from differences in resource availability.

    Cumulated cost effects from national regimes on planning, permitting, grid connection and usage, taxation and financing range from 12 EUR/MWh in Germany to 26 EUR/MWh in Belgium. A wind park in Belgium would thus need to have 20% more full load hours than a German wind park to equalise these effects of the national policy environment.

  2. 2

    EU rules on renewable energy push for enhanced cross-border cooperation, but currently do not offer a consistent framework for implementation.

    Cross-border cooperation on renewables is addressed i.a. in the EU Renewable Energy Directive, in the EU Regulation on the Governance of the Energy Union and in EU State Aid rules. A prerequisite for successful implementation is to better understand how national regulatory environments outside renewable energy support frameworks shape investor choices.

  3. 3

    Cross-border renewables cooperation needs to address the impacts of differing regulatory conditions on LCOE.

    Governments and regulators involved may agree on the coordinated convergence of some regulatory conditions towards recognised best practice. Where convergence is not feasible or desirable, the focus will be on whether and how to account for existing differences in the design of competitive auctions.

  4. 4

    Insights from cross-border renewables cooperation are essential for future European approaches.

    These learnings will be relevant e.g. in the context of the EU 2030 renewables gap filler mechanism or the Renewable Energy Projects of European Interest.

  1. 1

    To achieve a 50 per cent share of clean electricity by 2030 at a minimum cost, China needs to add around 35 GW of wind energy and 65 GW of solar energy per year between 2020 and 2030.

    This would be roughly in line with the quickest deployment levels seen in previous years. With a rapid decline in technology costs, wind and solar can serve as a substitute for new nuclear and hydro, which current plans foresee growing at an unrealistically high rate.

  2. 2

    “Flexibility” will need to become the new watchword in China’s power system, as by 2030 roughly 25 per cent of the power supply comes from variable renewables.

    Restructuring the power system will be essential in order to keep it reliable and cost-effective. Inflexible baseload technologies and non-merit-order-based, coarse-scale dispatch are incompatible with a system that is increasingly dominated by weather-dependent power generation technologies.

  3. 3

    China has initiated a number of important reforms already, but fundamental challenges still lie ahead.

    Recent policy reforms have moved in the right direction, as China has started pilot projects for emissions trading, has reviewed its renewables remuneration scheme, and has acknowledged the need to create a power spot market. However, fundamental challenges remain to be addressed. These include overcapacity in coal-fired assets, an inflexible dispatch system, and a lack of data transparency and accessibility for market participants.

  4. 4

    Five Golden Rules will help build a consistent policy regime and guarantee system reliability and cost-effectiveness.

    China has the opportunity to leapfrog to a renewables-led power system design that ensures cost-effectiveness and reliability. The Five Golden Rules we develop in this paper will help policy makers view the various policy instruments and emerging sectoral markets both pragmatically and coherently while taking into account interdependencies and avoiding inconsistencies:

    Golden Rule 1: Use existing generation capacity efficiently by implementing short-term markets

    Golden Rule 2: Incentivise flexibility to ensure system reliability and adequacy

    Golden Rule 3: Provide stable revenues for new investment in renewables

    Golden Rule 4: Manage the decline of coal and its structural consequences

    Golden Rule 5: Acknowledge the pivotal role of transparency and data accessibility

  1. 1

    Europe needs a “Renewable Energy Cost Reduction Facility (RES-CRF)” to fill the high-cost-of-capital-gap which currently exists in many member states in Central and South-Eastern Europe.

    Wind and solar are today cheap technologies that are on equal footing with coal and gas. However, high cost of capital oftentimes hinders renewables projects from going forward, even when there is excellent potential. Bridging that gap, a RES-CRF will bring significant cost savings to consumers and taxpayers in those countries

  2. 2

    The RES-CRF would provide a fifty-fold leverage of private-sector finance and will phase-out automatically as market confidence in high cost of capital Member States increases.

    The risk of the financial guarantee underpinning the RES-CRF ever being called is very small. We propose a set of concrete safeguards to ensure only high quality renewable energy investments will benefit and to avoid over-commitments.

  3. 3

    The next EU Multiannual Financial Framework should be used to finance the RES-CRF as a cheap support for the 2030-targets.

    Committed public funds to implement Article 3.4 of the new EU Renewable Energy Directive would create scope for establishing the RES-CRF. This would help Europe to meet its 2030-renewable energy target and enable all Member States to benefit from low-cost renewable energy.

  4. 4

    A pilot project should be launched before 2020 for proof of concept.

    A key design feature of the RES-CRF is its flexibility. Being largely based on contractual arrangements, it can be tested in specific sectors or Member States before a wider roll-out. Launching a pilot project before 2020 would help strengthen confidence in the instrument. A pilot can be financed from the running EU budget.

  1. 1

    Renewable energy investments are more capital intensive than investments in fossil-fired power generation.

    They are also much more sensitive to political and regulatory risks. This is highly relevant when addressing Europe’s 2030 renewables framework consisting of a binding EU target without binding Member States targets.

  2. 2

    The costs of capital for renewables vary widely between Member States.

    Perceived ex-ante risks translate into country specific premiums on the costs for renewable energy investments that have nothing to do with technology risks or weather conditions.

  3. 3

    Equalising costs of capital throughout the EU would save taxpayers at least 34 billion Euros to meet the 2030 renewables target.

    It would also allow for broader sharing of the social, economic and health benefits of renewable energy investments, and would particularly benefit EU Member States with lower than average per capita GDP.

  1. 1

    Short-term markets in Central Western Europe are characterised by a rather inefficient patchwork of flexibility enabling and disabling design elements.

    Some key design elements of intraday and balancing markets as well as imbalance settlement rules distort wholesale power price signals, increasing the cost of providing flexibility. This highlights the need to adjust key market design elements and requires continuous political momentum to coordinate efforts regionally.

  2. 2

    Current market designs are biased against demand side response and renewables.

    Restrictive requirements for market participation, mainly relating to demand response and renewables, constrain the flexibility potential. In the balancing markets, small minimum bid sizes and short contracting periods would be required. A regulatory framework enabling independent aggregation should be implemented for fully tapping the flexibility potential.

  3. 3

    Balancing market rules show large differences across the region, leading to inefficient pricing in preceding day-ahead and intraday markets.

    A joint balancing market design in the PLEF region with short product duration, late gate closure and marginal pricing would enable efficient cross-border competition for flexibility services. Getting the pricing right in balancing mechanisms is important as it support sefficient pricing in preceding day-ahead and intraday markets – where most of the flexibility is traded.

  4. 4

    Cross-border intraday trading needs reform to improve efficiency and enhance liquidity.

    Intraday markets are critical for integrating wind and solar, as they allow for trades responding to updated generation forecasts. Today, explicit cross-border capacity allocation as well as misalignments in gate closure times across the region and differing product durations result in inefficient intraday energy and interconnector capacity allocation. Thus, harmonised rules and improved implicit cross-border allocation methods are needed, e.g. improved continuous trading or intraday auctions.

  1. 1

    The European power system will be based on wind power, solar PV and flexibility.

    The existing climate targets for 2030 imply a renewables share of some 50 percent in the electricity mix, with wind and PV contributing some 30 percent. The reason is simple: they are by far the cheapest zero-carbon power technologies. Thus, continuous investments in these technologies are required for a cost-efficient transition; so are continuous efforts to make the power system more flexible at the supply and demand side.

  2. 2

    Making the Energy-Only Market more flexible and repairing the EU Emissions Trading Scheme are prerequisites for a successful power market design.

    A more flexible energy-only market and a stable carbon price will however not be enough to manage the required transition to a power system with high shares of wind and solar PV. Additional instruments are needed.

  3. 3

    A pragmatic market design approach consists of five elements: Energy-only market, emissions trading, smart retirement measures, stable revenues for renewables, and measures to safeguard system adequacy.

    Together, they form the Power Market Pentagon; all of them are required for a functioning market design. Their interplay ensures that despite legacy investments in high-carbon an inflexible technologies, fundamental uncertainties about market dynamics, and CO2 prices well below the social cost of carbon, the transition to a reliable, decarbonised power system occurs cost-efficiently.

  4. 4

    The Power Market Pentagon is a holistic approach to the power system transformation. When designing the different elements, policy makers need to consider repercussions with the other dimensions of the power system.

    For example, introducing capacity remunerations without actively retiring high-carbon, inflexible power plants will restrain meeting CO2 reduction targets. Or, reforming the ETS could trigger a fuel switch from coal to gas, but cannot replace the need for revenue stabilisation for renewables.

From study : The Power Market Pentagon
  1. 1

    Wind and solar PV drive power system development.

    As part of Europe’s renewable energy expansion plans, the PLEF countries will strive to draw 32 to 34 percent of their electricity from wind and solar by 2030. The weather dependency of these technologies impacts power systems, making increased system flexibility crucial.

  2. 2

    Regional European power system integration mitigates flexibility needs from increasing shares of wind and solar.

    Different weather patterns across Europe will decorrelate single power generation peaks, yielding geographical smoothing effects. Wind and solar output is generally much less volatile at an aggregated level and extremely high and low values disappear. For example, in France the maximum hourly ramp resulting from wind fluctuation in 2030 is 21 percent of installed wind capacity, while the Europe-wide maximum is only at 10 percent of installed capacity.

  3. 3

    Cross-border exchange minimises surplus renewables generation.

    When no trading options exist, hours with high domestic wind and solar generation require that generation from renewables be stored or curtailed in part. With market integration, decorrelated production peaks across countries enable exports to regions where the load is not covered. By contrast, a hypothetical national autarchy case has storage or curtailment requirements that are ten times as high.

  4. 4

    Conventional power plants need to be flexible partners of wind and solar output.

    A more flexible power system is required for the transition to a low-carbon system. Challenging situations are manifold, comprising the ability to react over shorter and longer periods. To handle these challenges, the structure of the conventional power plant park and the way power plants operate will need to change. Renewables, conventional generation, grids, the demand side and storage technologies must all become more responsive to provide flexibility.

  1. 1

    Already now, Germany and France are helping each other guarantee security of supply.

    Whenever there iscapacity shortage in one country, prices in that country rise, favoring power plants in the other country to export. This is done automatically via market coupling.

  2. 2

    A joint German-French shortage situation is currently very rare, but may occur more often.

    A cross-border challenge in security of supply arises only during days with very cold weather and very little wind in both countries at the same time. An analysis of historical weather data suggests that after 2023 this might occur about six days in ten years.

  3. 3

    The unilateral introduction of a capacity mechanism in France benefits French power generators and German consumers – but the redistributive effects are likely to be small.

    Different market designs between Germany and France will generate some redistributive effects, but they are limited by the level of interconnections between the two countries (currently 3 GW) and joint market coupling with other European countries.

  4. 4

    The French decentralized capacity mechanism and the proposal developed by the German energy associations BDEW/VKU, though globally based on the same principles, differ in important respects.

    The French proposal, while effectively decentralized by nature, relies significantly on regulated components, with a centra lrole going to the TSO. Similar design elements are currently missing in the BDEW/VKU model, leaving the question open as to who would actually supervise, control and sanction this scheme in Germany.

  5. 5

    Cross-border participation in capacity mechanisms raises fundamental technical and regulatory questions.

    These questions include monitoring and control issues as well as rules for delivering capacities in foreign markets without interfering with market coupling. Addressing these questions requires political and technical cooperation on both sides of the border, especially when it comes to situations of joint scarcity.

  1. 1

    Tendering procedures for renewable energy need to be carefully designed.

    The introduction of competitivebidding for a specific renewable-energy technology in a given country needs to be preceded by a thorough analysis of the conditions for successful tendering, including market structure and competition. Specific project characteristics of the various renewable-energy technologies must be considered appropriately in the auction design.

  2. 2

    Pilot tenders should be used to enable maximum learning.

    Prior to adoption of tendering schemes, multiple design options should be tested in which the prequalification criteria, auction methods, payment options, lotsizes, and locational aspects are varied. Learning and gaining experience is of utmost importance, as poor auction design can increase overall costs or endanger deployment targets.

  3. 3

    The most challenging technology for auctions is onshore wind.

    Experiences made with auctions for certain technologies (e.g. solar PV) cannot be readily applied to other types of renewable energy. Onshore wind is particularly difficult due to the complexity of project development, including extended project time frames (often over two years), the involvement of multiple permitting authorities and the need for local acceptance.

  4. 4

    Inclusion of a variety of actors is a precondition for competition and efficient auction outcomes.

    The auction should be designed to facilitate a sufficiently large number of participating actors, as this will minimise strategic behaviour and ensure a level playing field for all actors, thus enabling healthy competition. As renewable deployment often hinges critically on local acceptance, enabling the participation of smaller, decentralised actorsin auctions is important.

Projects

Latest News

All Content

Stay in touch. Subscribe to our newsletter.