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.

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