Time to design tomorrow’s climate-neutral power markets

The views expressed are those of the author and do not necessarily reflect the position of FORESIGHT Climate & Energy

Report into electricity market design is due to be published in April 2022

European electricity markets rely on a complex set of trading arrangements. As a result, any substantial changes would take years to design and implement. Market reform is, therefore, unlikely to provide solutions that alleviate the current energy price crisis. Nevertheless, it can reduce the chance of future crises.

For that, tomorrow’s market needs must be the blueprint for today’s reform agenda. The European power system must successfully decarbonise during the 2030s to meet the Paris Climate Agreement and the European Green Deal goals, and to support the reduction of the EU’s energy dependence. This shift means major changes to the energy resources used and how the system operates.

Although some Member States may decide to include nuclear and decarbonised gases in their energy mixes, a vast amount of electricity needs to come from renewables. Therefore, electricity markets must ensure the construction of enough new renewable capacity.

The good news is that most countries are getting better at supporting renewables construction and their approaches can serve to accelerate the necessary investment. However, the main challenges have to do with the variable nature of wind and solar electricity.

TRANSPORT CHALLENGE

Firstly, the grid infrastructure must be in place to ensure electric transport can serve centres of demand. However, power network infrastructure can take many years to construct and it is critical that transmission bottlenecks do not constrain renewable generation. This means it is necessary to anticipate where renewable capacity will be built and ensure the network infrastructure is in place ahead of need.

This anticipation is crucial in regions such as the North Sea, where a whole new grid will be necessary to connect offshore wind capacity. Beyond simply connecting renewable capacity, the network and associated trading arrangements must allow the electricity to flow across the continent.

This would ensure that Europe meets its energy needs most efficiently and reduces its dependence on gas as a backup fuel source. EU countries should not waste huge sums of money exploiting low-efficiency domestic resources. Instead, they should all have access to the strongest northern wind and the brightest southern sun. This must remain a core objective of the single EU energy market.

SUPPLY AND DEMAND

Even when renewable electricity is traded over wide geographical regions, it will still be necessary to align demand with available supply. To do this cost-effectively will be challenging.

Sadly, there is little consensus on how to design markets to utilise demand flexibility. There is also virtually no discussion on how to deploy devices and control infrastructure. Perhaps one point of agreement is that the current market and regulatory arrangements will not achieve what is required.

Unlike for power generation, there is no systematic framework to drive the deployment of assets that will deliver demand flexibility. It is difficult to imagine that short-term power market prices coupled with a complex array of grid service markets can trigger the necessary deployment rate.

Moreover, a price-driven approach would create social inequities, as those unable or unwilling to adopt new technologies would incur higher energy costs. Instead, the provision of demand flexibility should be part of an overall strategy to upgrade buildings alongside improvements in energy efficiency and heating decarbonisation.

Deployment of smart devices and control technologies in consumer premises alone will not be enough. It is also necessary to harmonise the approach to valuing demand flexibility at each location and time and use digital technologies to despatch demand resources efficiently. Currently, existing markets have not stimulated growth in demand flexibility.

Besides, system operators are wary of changing their approach to balancing supply and demand or exploiting the potential of digitalisation. Therefore, lawmakers must ensure the deployment of core digital infrastructure and clarify how consumers will provide services to the grid. In other words, they must define the future market arrangements.

New market arrangements must incentivise consumers to provide demand flexibility and other grid services. Here, a fundamental decision is whether consumers will have to respond to prices themselves or their devices will be disconnected automatically in line with a pre-determined set of rules.

It is also necessary to decide whether system operators will directly manage the interface with consumers or if it will be the role of aggregators contracted to provide services to system operators.

These issues must be addressed with urgency. Consumers will play a critical role in the power grid decarbonisation. However, current market structures do not encourage their participation or provide sufficient protection from market volatility.

The analysis by the Association for Cooperation of Energy Regulators must go beyond assessing today’s energy crunch and, instead, evaluate how the current market design supports the transition to net zero in the 2030s. The question is not whether market reform is necessary but how to progress it urgently to meet tomorrow’s challenges. •

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