How to reinvent electricity markets after COP21

Electricity markets are undergoing massive transformation, as the push for low-carbon power generation shifts the industry towards high investment in renewables and other new technologies even as demand stagnates or declines in many countries.

Just in time, the IEA presents Re-powering Markets: Market design and regulation during the transition to low-carbon power systems. Drawing on the Agency’s review of best practices in electricity market design, mainly in Europe, the United States and Australia, the study offers guidance to governments, regulators, companies and investors on how to transition to low-carbon generation.

Building the electricity markets of the future, Re-powering Markets explains, requires a comprehensive framework that encourages low-carbon investments and operational efficiency but also keeps security of supply as a top priority. That requires efficient markets, which are best achieved by introducing prices that reflect supply and demand conditions as often as possible and as close as possible to locations where the energy is generated or consumed. Markets are adopting technology that allows such pricing, including day-ahead, intraday and real-time trading, as well as by zone to stimulate cross-border trade. The detailed price information needs to be transparent to communicate the cost of electricity in specific circumstances as well as the relative value of different forms of electricity generation so that all participants, even from neighbouring markets, learn where and when to operate and invest.

Furthermore, efficient markets unlock flexibility to deal with renewables’ variability, like when and where the wind does not blow or the sun does not shine – or when and where wind and solar generation is abundant – as well as weather forecasting errors and network congestion. 

Besides efficient markets, the shift to a low-carbon energy system requires a robust carbon price to help reveal the right value for various technologies. That is part of the regulation with long-term arrangements that is necessary to attract investments in a timely manner and at the scale required. Investors, governments and consumers all have to share the risks in the transition, Re-powering Markets explains, to ensure efficient and lowest-cost evolution.

More than just generation is at stake. Networks, too, are critical: improving and expanding power grids, including across borders, helps ensure successful integration of higher shares of wind and solar power as well as increases energy security. Proper governance is necessary to see the bigger, often transnational, picture critical to a modern electricity system: options examined in the book include transmission auctioning. Regulation of distribution must also be modernised to take into account the potential of batteries as well as consumers who also produce renewable electricity.

As the markets evolve, though, shortages of capacity can result in scarcity prices. While these prices are critical to incentivise generators to produce as well as to get consumers to reduce demand, Re-powering Markets makes clear the need for an adequate regulatory framework during hours of capacity shortage.

Besides looking at price spikes, the book examines other ways regulators can cope with the huge uncertainty of decarbonisation pathways and policies, including capacity mechanisms that pay for maintaining adequate generation to meet politically set reliability standards. It also details the opportunities that demand response offers through dynamic pricing and the pooling of consumers through new technologies, including the impact of increased electrification from widespread adoption of electric cars and other new technology.

In the end, there is no definitive market design for the low-carbon energy systems of the future. But governments and industry around the world must adjust as new technologies prompt constant evolution, and Re-powering Markets shows them how to navigate that transformation by developing markets that provide secure, sustainable and affordable electricity.

Re-powering Markets is part of the IEA Electricity Markets Series. Download the book for free here. Download the launch presentation here.

About the IEA

Founded in 1974, the International Energy Agency was initially designed to help countries co-ordinate a collective response to major disruptions in the supply of oil. While this remains a key aspect of its work, the IEA has evolved and expanded. It is at the heart of global dialogue on energy, providing authoritative statistics and analysis. The IEA examines the full spectrum of energy issues and advocates policies that will enhance the reliability, affordability and sustainability of energy in its 29 member countries and beyond. 

Photo by NASA