Electricity market design and renewable energy deployment

 Will the evolution towards a power system with high shares of variable renewable energy sources (VRE) require a new electricity market design?

Real-world electricity market design is diverse, complex, multi-level and path-dependent, ranging from liberalised markets to integrated utilities, from very flexible power systems to very inflexible systems. Characteristics of VRE sources like solar and wind energy provide challenges to these systems and markets, once deployed at high shares. These are mostly linked to capital intensity and low short-run marginal cost, limited predictability and variability, and decentralised generation.

The RES-E-MARKETS project aims to answer the question: how to reform current market and regulatory frameworks in order to accommodate high shares of VRE in a timely, cost-effective and secure fashion? To do so, the IEA RETD TPC commissioned FTI-CL Energy and Neon Consulting to offer practical, relevant and implementable policy recommendations differentiated between jurisdictions with and without liberalised wholesale electricity markets, for a time horizon of 2050.

Four power system prototypes were selected to ensure the whole coverage of the electricity market, namely Energy-only market, Vertically integrated utility, Hybrid market and Prosumer market. The report includes (i) high-level recommendations focusing on short-term system operations, system development and investment, and governance and regulatory framework, (ii) recommendations for whole market design, and (iii) recommendations for retail market design.

High-level and specific criteria used to evaluate these market and system prototypes are:


Key messages

With regard to the wholesale market, the deployment rate of flexible resources as well as the willingness of policy makers to support specific technologies will be the key drivers determining (1) whether some incremental reforms to the current short-run marginal-cost based power markets will be sufficient, or (2) whether more radical reforms are required to introduce hybrid power markets.

With regard to the retail market, all markets will have to introduce reforms to drive an efficient system development given the rise of prosumers’ development. The potential move towards energy services (away from a commodity pricing approach), as well as the level of engagement of consumers will drive the speed and magnitude of the market reforms required.

Nevertheless, regardless of the market prototype, policymakers need to address three main areas to ensure a smooth transition to a system with high share of VRE. A snapshot of high-level recommendations includes:

Short-term system operations

  • Remove barriers to scarcity pricing to allow power prices to convey the high value of electricity at times of scarcity;
  • Ensure that the market design creates a level playing field and fosters the development of flexibility in its various forms;
  • Introduce locational signals to coordinate in real time many decentralised players and transmission and distribution networks;
  • Develop new risk hedging and risk transfer mechanisms specifically tailored to the new types of risks; and
  • Revisit the optimal mix of decentralised (price based) and centralised (planned) steering mechanisms.

System development and investment

  • Policies supporting the development of efficient risk transfer and risk hedging mechanisms will be needed to ensure the financeability and bankability of capital intensive technologies and to reduce the cost of capital;
  • The market design should introduce long-term coordination mechanisms for the decision on siting and timing of investment across centralised / decentralised generation capacity and network expansion; and
  • A regulatory framework of the network development should evolve to include necessary elements of incentive regulation to drive efficient and timely development of the grid infrastructure.

Governance and regulatory framework

  • Policies supporting technological innovation and smart, unconventional solutions are needed; and
  • An efficient allocation of responsibilities between the different geographic levels of governance is warranted.

Future research will need to focus on the interface between wholesale and retail markets and the consistency of price signals across these different markets. In the meantime RES-E-MARKETS provides valuable insights and recommendations for both wholesale and retail market design in the report above.