The market design column – The Economist on the disruptive power of wind and solar

Last February the Economist featured an article titled “Wind and solar power are disrupting electricity systems - But that’s no reason for governments to stop supporting them”:

http://www.economist.com/news/leaders/21717371-thats-no-reason-governments-stop-supporting-them-wind-and-solar-power-are-disrupting

Several colleagues mentioned this article to me. Some of them were appalled because it places clean energy in a dirty light.  Others were appealed because it explains the challenges that traditional utilities face. For me there was not so much news under the sun.  Although indeed, one very basic market rule is still missing …

 The first disruptive effect mentioned in the Economist article, is that the increasing share of subsidized wind and solar is reducing power prices and thus the profitability of conventional power plants. The authors seem to suggest that capacity payments to such conventional plants become necessary. This is however too simplistic. The fact that some conventional plants become loss making and will have to close down is a normal and desirable effect of the support to renewable sources.

Secondly, the article suggests that such capacity payments to conventional power plants would be a new form of subsidy. Again this is too simplistic. In theory, a well-designed capacity market can make sense, if it is designed to reduce the dependency on uncertain scarcity rents. Fact is that in an Energy Only Market, generators are dependent on scarcity rents to be able to recover all fixed costs. The actual emergence of scarcity is however very uncertain and as a result investors will require a risk premium. Such risk premium is especially relevant for investments in peak capacity (possibly also demand side response) that is relatively more dependent on scarcity rents than base load capacity. However that is all theory. In practice, it is impossible to design the perfect capacity market. It may easily be over-dimensioned. Or it becomes a new tool for politicians to steer investments in a certain direction. As a result inefficiencies are introduced in the market and eventually consumers will pay the bill. 

 Finally, the Economist presents a solution, namely a “redesign of power markets to reflect the new need for flexible supply and demand … that  should adjust prices more frequently, to reflect the fluctuations of the weather.” Here, I agree with the solution, although I would not call it a redesign. Actually, this market design already exists. Market participants are able to trade on forward markets towards day-ahead and intraday markets with increasing granularity. The German intraday market shows a rather liquid market with quarter-of-hour products that are traded even up to delivery. This is important for those who provide market access for renewable energy sources. And although the share of wind and solar in Germany has been constantly growing over the last years, the TSOs are not faced with increasing balancing problems. On the contrary! In the meantime the actual activation of operating reserves has gone down!

This does however not mean that the current market design is perfect. Improvements are possible and needed. The most fundamental issue that still needs to be arranged for is “VoLL pricing in periods of actual physical scarcity”. An actual brown-out, caused by scarcity, may seem to be hypothetical and thus irrelevant for many. However, consumers and their suppliers need to be exposed to the credible risk, that if such event happens, imbalances will still be settled at a relevant price. And the relevant price would be the Value of Lost Load. Unfortunately this very basic market rule is still missing in all European power markets.

Disclaimer: The views as expressed in this column do not necessarily reflect the views of Statkraft

Paul Giesbertz

paul.giesbertz@statkraft.com