A QUESTION OF MARKET CONTROL

Grids need to accommodate a host of new and variable low-carbon assets, but who should manage how they operate and what they get paid remains a thought exercise despite the changes already happening

Early March 2023 saw a buzz ripple through energy circles as the European Commission prepared to release new proposals on electricity market design. Mention of power purchase agreements, contracts for di erence and subsidy limitations in a leaked version of the proposal was “music to my ears”, renewables nance heavyweight Jérôme Guillet wrote on his Substack blog.

Lars Stephan of US-based battery rm Fluence praised the draft for having, “The strongest legislative language of the European Commission yet on the need for exibility and the important role of energy storage for the integration of renewables.”

Meanwhile Kristian Ruby of the European electric utility industry body Eurelectric was more cautious over the proposed market reforms. Some of the measures discussed in the run-up to the proposal could be “poison for investor con dence”, he said.

Having endured sky-high power bills for much of 2022, few European consumers would doubt that the continent’s electricity markets are due for reform. However, few outside of the power sector could imagine the complexity of the system that delivers electricity to their businesses and homes—and the intricacies of how that energy is priced.

Modern electricity provision depends on two interlinked systems. One is the infrastructure that ensures electricity supply always matches demand. The other is a nancial market that prices every kilowatt-hour based on the availability of energy at a given point in time. Both systems can be thrown o kilter, a ecting the other in the process.

Grid Challenges

Imbalances on the physical network can lead to blackouts, while those on the nancial side can result in unexpectedly high prices. Grid operators try to avoid such imbalances, but doing so is becoming more di cult as generation moves from dispatchable thermal plants to variable wind and solar power.

Hence the need for a rethink, which in Europe was further emphasised by events in 2022.

It would have been a tough year even without Russia’s invasion of Ukraine, analysis by energy insight rm EnAppSys shows. Drought depleted Nordic hydro reserves, forcing Norway to limit its renewable generation and import more energy from its neighbours than usual.

The drought also sapped the rivers used for nuclear plant cooling. France’s signi cant nuclear eet, already a ected by scheduled outages, was forced to scale back operations further with output dropping even lower than it had when the lockdowns induced by the Covid-19 pandemic slashed demand.

The issues “caused the nation’s day-ahead prices to rise to record highs,” EnAppSys says, “resulting in a switch in the position of the French market from being one of the largest exporters of power in Europe to being a net importer.”

Gas Prices

It was against this backdrop that Europe also faced the loss of Russian gas supply, vital for winter electricity production. Prices on the Dutch Title Transfer Facility gas market hit a record of €308.18 per megawatt-hour in August 2022, EnAppSys says. The price of gas is signi cant because wholesale electricity markets in Europe operate on a marginal pricing model.

In this model, di erent forms of generation enter the system based on how much they cost, with the lowest-cost technologies—typically solar and wind— being given priority. Provided they cover all that is needed, electricity prices stay low.

However, if demand goes up then the wholesale price rises to accommodate more expensive forms of generation. When gas hit record levels, then electricity prices in areas burning gas also shot up.

Price Caps

This happened in many European nations, forcing lawmakers to implement arbitrary price caps that Eurelectric’s Ruby slammed in a social media post. “Politically agreed revenue caps are not only di erent per technology,” Ruby said. “They are also di erent per country, creating serious distortions of the internal market.”

Coming on top of in ation and “other market interventions”, the caps were denting investor condence, he said, with 2022 European wind turbine orders down 47% on 2021 levels. “A disruptive reform would cloud the horizon further and lead to a multi-year slump in investments,” Ruby wrote. “If the internal electricity market is permanently damaged, that could be the beginning of the end for the entire internal market.”

Ruby’s hyperbole may have been coloured by the need to protect the interests of Eurelectric’s utility members, which have plenty to lose in a shakeup of electricity market rules. However, his downbeat view

Gas price volatility

Gas prices in Europe in 2022 varied considerably more than previous years, sending repercussions across the energy sector of market conditions was appropriate, with the situation of 2022 highlighting a range of challenges.

Facing the loss of Russian gas, the European Commission rushed out the RePowerEU legislative package to speed up renewables permitting and foster investment in clean energy.

Yet at a time when Europe should have been racing towards a low-cost, low-carbon economy, governments were unable to ll renewable energy auction quotas and the EU failed to greenlight a single o shore wind farm in the whole of 2022.

These problems are not all the result of electricity market design, but the extraordinary events of 2022 highlighted tensions that are growing as European grids move to a model dominated by intermittent distributed generation. Such tensions are not unique to Europe but will ultimately emerge in all established electricity markets as they go through an energy transition.

Two Visions

A central challenge for such markets is how to go from managing a few generation assets that can be turned on and o more or less at will, to dealing with, and rewarding, thousands of market participants delivering intermittent supplies. To complicate matters further, the energy transition is blurring the distinc- tion between buyers and sellers.

Electricity markets increasingly need to recognise and reward consumers who, for example, take part in demand response programmes (page 50) or sell excess generation from distributed energy resources (DERs) such as solar panels. How markets might do this was summarised by American researchers Lorenzo Kristov, Paul De Martini and Je rey Taft in a 2016 paper titled “A Tale of Two Visions: Designing a Decentralized Transactive Electric System”.

The trio contrasted two views of market control. “One vision is based on a centralised, whole-system optimisation performed by the transmission system operator (TSO), which may also operate wholesale spot markets,” they said. “Under this model, the TSO needs detailed information and visibility into all levels of the system, from the balancing authority area down through the distribution system to the meters on end-use customers and distribution-connected devices.”

The other vision, “Involves a decentralised, layered-decomposition optimisation structure, for which optimisation at any given layer of the system only requires visibility to the interface points with the next layers above and below. The choice of which vision to aim for in any jurisdiction will have major implications for specifying the complementary roles

POLICY

Changes need to be made to how electricity markets are managed so that they can handle the pace of the energy transition, but there is li le consensus about what tweaks are actually required