Abstract:
The electricity markets in Europe were designed with the aim of lowering energy supply costs and thus increasing the competitiveness of the European industry. The large electricity markets in the USA also operate to reduce over-all costs in a certain network area. In a market dominated by fossil fuel power plants such a market works. The classic merit order is made up of nuclear generation plants (marginal costs almost zero) via coal and gas fired assets up to oil or gas fired peaking plants (low efficiency, high marginal costs) for the high demand hours. Plants with very low marginal costs and little flexibility will bid at (close to) zero. They accept the price level set by others. Higher cost (flexible) plants will bid more in line with opportunity costs and try to optimize income over fewer load hours.
Network capacity could keep pace with the growth of demand and generation because this growth was predictable and stable. Planning and building a large generation asset can take a decade. Today, the share of renewable generation in the generation mix is increasingly being felt. There are days in spring and summer on which Germany is completely supplied by solar and wind. This rapid change in the generation mix puts into question whether the current market design is still adequate.
The current electricity market design is built on a few assumptions:
1. that the owners of a power plant do have marginal costs,
2. that the owners of a power plant can decide to run the plant or not,
3. that location (in the power network) is not very relevant.
These effects are strengthened by the fact that in large areas power demand is not growing. The trend of energy efficiency will not be reversed. As a result of the above, (term) wholesale power prices have now become low and also little volatile. Price movements are limited because periods of oversupply of renewables are followed by periods of oversupply of fossil fueled power. The ‘lubricant’ of a market: price volatility has disappeared in the longer term markets and is only still there in the very short term markets.The other ‘new’ phenomenon is a shortage of network capacity. The planning and construction of power networks takes much longer that than planning and construction of (especially) solar PV assets. Also, the unplanned production pattern of renewable assets raises the question whether enough network capacity for all produced kWh’s has to be available at all times.
Although the variable costs of solar and wind may be low, these sources are not at all for free. The lack of meaningful market prices is not only a problem for fossil power plants. It is definitely also an issue for solar and wind. We need new signals to drive investment and dispatch. Because CAPEX are so dominant in renewable generation, the risk is very ‘front-loaded’. No investor will put his money in a market where (marginal) prices are close to zero. In a CAPEX game, the investment risk will have to be allocated up-front. It is hard to see how generators will take this risk on the basis of a market in which marginal system cost are decreasing. Long term fixed pricing for the generation capacity will have to be agreed before the investment is made.
What then has to be steered (through price signals) is the capacity to balance supply and demand. In other words, capacity to transport, store and deliver is much more important than the energy. Capacity is the real scarce resource. A market for capacity will have to be developed. What is meant here is not the capacity market advocated by power producers. It is not about back-up. What is meant here is the long term and short term pricing of capacity on the grid. This makes transparent where there is a scarcity of capacity and what is the value of linking supply to demand. If we can put such a system in place then the rational solution can be sought by all market players. The article elaborates how this can be done.
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