Electricity Market Design and RE Deployment RES-E-MARKETS

Electricity Market Design and RE Deployment RES-E-MARKETS September 2016

Content 1. Context and methodology 2. A theoretical framework for market design assessment 3. Key challenges for power system with high shares of VRE 4. Energy only market 5. Vertically integrated utility 6. Hybrid market 7. Prosumer market 8. Policy recommendations www.iea-retd.org 2

1. Context and methodology www.iea-retd.org 3

FTI Consulting is a multidisciplinary international international consulting company. Neon is a specialised consulting boutique FTI Consulting activity Neon Consulting activity INTERNATIONAL SCOPE Over 4,200 professionals in 24 countries on 6 continents PROFESSIONAL EXPERTISE Reputable consultants in a variety of domains with respect to international clients ENERGY EXPERTISE FTI-CL Energy experts have advanced expertise in the issues of electricity market design Neon is a Berlin-based boutique consulting firm for energy economics. We combine expertise on economic theory with advanced modeling capabilities and extensive industry experience. Neon specializes in six areas: 1. Market value of wind and solar power 2. (Whole) system costs 3. Balancing power 4. Market design 5. Power market modeling 6. Training seminars www.neon-energie.com www.iea-retd.org 4

Project context: Toward high shares of renewables in the generation mix The share of variable renewables (VRE) in electricity generation in selected regions In a carbon-constrained world, variable renewables will supply a large share of electricity IEA ETP 2014 2 degrees scenario: VRE represent 30-45% in most world regions by 2050 (other studies provide similar estimates) Source: IEA (2014): Energy technology perspectives, 2DS scenario. www.iea-retd.org 5

The 3 stages of RES development Rising share of Renewables Supporting RES development Design of RES support policies RES on the side of power market Source: FTI-Cl Energy and NEON Mainstreaming RES RES integration into market RE-design of support mechanisms Design power market around RES Changes to market design for high shares of RES Allowing phase out of support for mature technologies Focus of this study These challenges will play out differently depending on the power system organisation: In jurisdictions with liberalised power sector: growing concern that competitive wholesale markets coexisting with policy support for VRE deployment may not provide a level playing field and may turn out unsustainable in the long-term In jurisdictions with vertically integrated utilities or hybrid systems: increasing RES capacity run by independent power producers may require revisions of the regulations defining the rules for grid access and system operation, ensuring the level playing field between the IPPs and the incumbent In jurisdictions with active prosumer participation: new questions emerge around the interface between retail and wholesale markets as well as on the regulation of distribution system operators www.iea-retd.org 6

Our approach: from the ideal market design toward transition pathways Project phases Inception A variety of current market designs Clustered case studies Task 3 Policy recommandati ons Task 2 Transition pathways Task 1 Prototypes and blueprints Analytical framework of Task 1 may be adjusted as a result of the results in Task 2 and 3 Markets time scale Spot markets Ancillary services Int l market integration Reducing political risks... Policy making as a search process: gradual adjustments, stakeholder involvement, learning Methods 2015 2016-2020 2020-2050 2050 Literature reviews Bilateral interviews Case study analysis Workshop time / VRE share www.iea-retd.org 7

2. A theoretical framework for market design assessment www.iea-retd.org 8

The wide scope of market design and policy frameworks Governance and institutional framework (roles of policy, independent regulator, etc.) Market design shapes the incentives under which all these decisions are taken Wholesale market RES support Retail market Market design consists of a set of rules specified by policy and regulation at multiple layers implemented in a large number of different laws, administrative orders, and market provisions. Balancing and ancillary services Infrastructure regulation (transmission, distribution) www.iea-retd.org Source: FTI-Cl Energy and NEON 9

Centralised Decentralised Market design is a coordination and risk allocation mechanism Power prices are a decentralised coordination mechanism Short term Efficient dispatch of all generation units based on variable costs Long term Signal retirement or new investment, trigger new entrants Long-term investment planning Energy-only Vertical integration Historical approach coordination of short term dispatch and long term investment centralised Liberalised markets Wholesale marker prices coordinate market players actions short and long term Centralised Investment markets with tenders for long-term contracts Hybrid approaches Wholesale market with a capacity mechanism Decentralised Shortterm dispatch Hybrids Most markets still hybrids with some form of regulatory intervention Public intervention differs depending on objective, type of intervention and risk allocation Vertically integrated Source: FTI-Cl Energy and NEON www.iea-retd.org 10

Criteria for ideal market design with high level of VRE Ultimate goal Economic welfare Constraints Policy objectives Operational constraints Wider energy system High-level criteria 1 2 3 4 5 Appropriate Appropriate Efficient Efficient Pricing risk rent dispatch investment externalities allocation allocation Dispatch signals Investment signals Appropriate risk allocation Robust to market power Environmental externality Specific criteria Ancillary services Geographical coordination Coherence short/long-term RES support schemes Minimizing financing costs Reducing policy risk Stranded assets management Power system externalities Interface with other sectors Locational signals Innovation incentives www.iea-retd.org 11

The diversity of power systems and implications for market design Vertically integrated monopolist Vertically integrated monopolist + IPPs www.iea-retd.org 12 Source: FTI-CL Energy analysis based on various sources including World Bank Single Buyer as a national genco, disco or disco, or a combined notional genco-transco or transco-disco + IPPs Many discos and gencos, including IPPs, transco as a Single Buyer with Third-Party access Power market of gencos, discos and large users, transco and ISO

Stylized models of power system organization: 4 different prototypes Real-world market and policy design is diverse, complex, multi-level and path-dependent. To address this diversity in a transparent way, we propose to study a small number of power system prototypes Each real-world market represents a combination of these prototypes Each prototype allows to focus on a specific aspect of market design Dispatch decisions Investment generation Examples Energy-only Decentralised through wholesale market prices Decentralised through wholesale market prices Texas, Australia, Europe Vertically integrated Centralised based on costs and other drivers Centralised based on planning Hybrid Decentralised through wholesale market prices Centralised based on planning and/or risk sharing mechanism Prosumer Decentralised through retail market prices Decentralised through retail market prices South Africa, US Brazil, UK Germany, Australia, California www.iea-retd.org 13

3. Key challenges for power system with high shares of VRE www.iea-retd.org 14

Three main challenges of VRE to power systems and market design Capital intensity Limited predictability and variability Decentralized and scattered generation Cost recovery: Credible investment incentives Credible investment signals Implications for the design of energy markets, capacity markets, support schemes Cost of capital: limiting risk exposure Exposure to risk, including policy risk, is a fundamental factor determining total system costs if the system is capital-intensive Price volatility More volatile prices Product definition (e.g., peak/off-peak) looses relevance Spot market design Reduced gate closer Higher frequency Both day-ahead and intraday Assurance of system stability Coordination between generation and grids Increased investment demand requires new approach to TSO and DSO regulation Locational price signals for generators needed Prosumers Retail prices becomes investment signal Base for taxes and grid fee erodes Need for new AS products, Many small producers Trade-off between policy e.g. providing system need access to wholesale flexibility and regulatory inertia markets risk Redesign AS to allow VRE participation www.iea-retd.org 15

Wholesale market challenges: Future production mix and the system marginal cost Future power systems Low variable cost technologies may supply close to 100% of demand Will need support of storage and flexible resources with high variable costs (e.g. gas with CCS, biomass) Possible future structure of system marginal cost: Very low-zero System MC low system flexibility - A large number of hours determined by low variable cost of VRE - Rare but large spikes in system MC during scarcity Continuous distribution of system MC - MC of electricity between zero and scarcity price - Material volumes of storage capacity, low carbon technologies with significant variable cost, DSR and interconnection smoothen the System marginal cost Electricity in 2050: Electricity to be almost fully decarbonised in Europe by 2050 with two thirds generated with low marginal cost IEA forecast high variability with zero to low levels one third of the time Source: Modelled price duration curve in ETP scenario, 2050 IEA 2015 RE-POWERING MARKETS www.iea-retd.org 16

Retail market challenges: adaptation to possible evolution of retail pricing approaches Current retail pricing Today, electricity is priced to customers as a commodity. Other commodities (e.g. telecommunication) were transformed from commodity to more service-oriented retail pricing Phone companies sell set of services rather than connection minutes Potential impact of high share of VRE Transition to a power sector with a high share of VRE and low variable cost could transform the retail energy supply into a service-oriented good Technology companies like Google or Tesla might bundle electricity consumption with other goods to increase cross-selling potential (including data collection) This could change the way the retail electricity market is designed, reducing the importance of retail electricity price for consumers decisions. Interface between retail and wholesale electricity commodity price under high share of VRE Despite the move toward service-oriented pricing on the retail, commodity price would likely remain an important driver of operation and investment decisions at the upstream level. Retail aggregators and retail suppliers would trade electricity at the wholesale level with reference to a wholesale commodity price and would re-package the product into the service-oriented good for the retail customers. The interface between retail and wholesale prices could evolve depending on the pricing approach for electricity in retail market. www.iea-retd.org 17

4. Energy Only market www.iea-retd.org 18

Energy Only market Presentation of the prototype What is Energy-only prototype? A market where generating capacity investments and short term operations are mostly driven by market signals in the energy and ancillary services markets and little other regulatory or policy intervention. The major challenges are investment incentives, driven either by expectations of future short-term prices alone or in conjunction with (structured or freely emerging) financial markets. Case study: energy-only market in Texas (ERCOT) Texas is one of the few examples of a power system featuring an energy-only market in North America with scarcity pricing. Case study: energy-only market in Australia (NEM) The NEM operates in the East and South-East of Australia, supplying about 80% of the electricity consumption of the country. NEM is an energy-only market with the Market Price Cap (MPC) set at a very high level of USD 8,900 per MWh ($AUT12,900/MWh). Case study: European energy only markets Most power markets in Europe share many characteristics of the energy-only market prototype, as there is no specific mechanism to put a value on generating capacity www.iea-retd.org 19

Energy Only market Critical elements of benchmark market design Element of market design Challenge presented by VRE Benchmark market design elements Design of spot and ancillary services markets Shift of the operational timeframe to real-time Increased capital intensity and price variability New requirements for AS products, and new constraints to provide them Move the spot price reference to the real-time price, e.g. Absence of barriers between real-time and ID/DA markets Single price imbalance prices Credible scarcity pricing Scarcity pricing mechanisms based on operating reserve demand curves Non-distortive market power and manipulation legislation Efficient valuation of flexibility services Spot ancillary services products (operating reserves) Technology-neutral balancing responsibility Locational price signals Increasing distance between generation and consumption Ensure locational differentiation of energy prices perceived by generators to ensure transmission/generation coordination Nodal or zonal energy prices Network injection charges Forward markets / hedging products Classical product definitions loose relevance (e.g., peak / off-peak) Increased capital intensity and price variability Fostering the liquidity of long-term markets Market makers New financial products to hedge against all spot products (e.g. operating reserves) Forward financial transmission rights www.iea-retd.org 20

Energy Only market Design of the energy and ancillary services markets In a benchmark market design, the real-time electricity price should reflect the true marginal costs of system balancing In many European countries, real-time prices do not provide an efficient price signal The real-time value of electricity is represented by the imbalance price in the balancing markets. System operators and regulators often discourage market players from responding to balancing signals. Imbalance prices are often designed to dissuade market participants to arbitrage between the traded markets (day-ahead and intraday) and the balancing markets (e.g. dual price imbalance price). Barriers to such arbitrage may dampen the price signals in the spot and forward markets. In contrast many US electricity markets are closer to the benchmark market design Day-ahead is considered as a forward market allowing trade in advance of real-time delivery to hedge the risks associated with the real-time market Efficiency of such hedge is achieved through measures facilitating arbitrage between the day-ahead and real-time markets: High consistency of the organisation between of the day-ahead and real-time markets. Virtual trading. www.iea-retd.org 21

Energy Only market Credible scarcity pricing In the benchmark energy-only market power prices should raise to the value of lost load (VOLL ~ 10-20k/MWh) at times of scarcity. In Europe, power prices cannot reach the VOLL because of explicit price caps ( 150-3000/MWh) and the risk of investigations under the competition law or REMIT regulation The Electricity Market in Australia (NEM) Features a very high Market Price Cap (MPC) set at ($12,900/MWh). Places few restrictions on offers of market participants. Transient market power during scarcity events is viewed as an important element. Texas (ERCOT) ERCOT s dispatch software includes an automatic process of ex-ante mitigation of market power. A special scarcity pricing mechanism is deployed that allows the energy prices to raise to a very high level in case of shortage of short-run capacity in meeting the demand for electricity and operating reserves. Average daily pool prices in NEM, 2003-2011 Source: Riesz, J, 2013, Will Australia s energy-only market work with high renewables? Operating reserves demand curve in Texas Source: Potomac Economics, 2015, ERCOT State of the Market report, 2014 www.iea-retd.org 22

Energy Only market Demand-side participation One of the key issues is the absence of active demand side participation Current market framework in Europe makes it difficult for all sources of flexibility to compete on a level playing field. Demand response is not widely allowed to participate in balancing markets. Except in few instances, demand-side response cannot be valued explicitly in the market. DSR is gradually allowed to participate in balancing markets and to provide reserves. They are also integrated in capacity mechanisms, which are being implemented at the moment, such as in France, the UK or Belgium. However, there is not yet a robust and clear framework to enable DSR operators and third party aggregators to value DSR in wholesale energy markets, except in France where a new regulatory framework was established in 2013-2014. Evaluation of European countries market framework for demand response Source: FTI-CL Energy, 2015, Toward the Target Model 2.0: Policy Recommendations for a Sustainable EU Power Market Framework www.iea-retd.org 23

Energy Only market Efficient valuation of ancillary services and reserves Efficient valuation of flexibility services provided by fast ramping generation, storage and demand response requires efficient markets for ancillary services, such as operating reserves. The cost to provide operating reserves is the opportunity cost relative to the energy market. The opportunity costs vary almost as much as the energy price varies. Marginal plants have the least cost of providing Operating Reserves (OR) and plants that are in the money or out of the money have a high cost of providing OR. Relationship between the reserve cost and the electricity spot price Source: Hirth & Ziegenhagen (2015): Balancing power and variable renewables In Europe, balancing reserve capacity is typically procured in advance of real time (sometimes months or years) and involves an equally long-term obligation to provide reserves. The lack of a short-term price signal for the reserve capacity does not allow a correct valuation of flexibility. Absence of the short-term price signal for reserve capacity excludes the use of the scarcity pricing mechanisms, such as in ERCOT. www.iea-retd.org 24

Energy Only market Locational price signals The economic value of electricity is different between locations, because of transmission constraints and losses. A benchmark market design signals this to investors by offering a higher price in such locations. There are four design options for locational price signals, ordered in increasing accuracy Locational grid connection charges Locational grid injection charges Zonal energy prices (European and Australian NEM) Nodal energy prices (US markets: PJM, New York, New England, California, Texas) Nodal day-ahead price differences in Texas Zonal systems are vulnerable to the VRE production In Europe TSOs have to limit the capacity of the cross-zonal transmission capacity because of inability of the zonal system to provide an economic allocation of the power flows induced by VRE ENTSO-E is running a bidding zone review, analysing the possible benefits of zones smaller than national in countries, such as France, Germany and Poland. ERCOT provides a recent example of transition from zonal to nodal market. The cost of intra-zonal congestion was found too significant and since December 2010 ERCOT is operating as a nodal market Source: ERCOT www.iea-retd.org 25

Energy Only market Development of hedging products Scarcity pricing exposes market participants to greater risk of price spikes and imbalance costs. Development of appropriate hedging instruments is a key pre-condition for an efficient functioning of energy only markets. Liquid markets across all time frames Low liquidity of forward electricity markets is a common problem Ofgem has found a targeted measure to address the liquidity problem. Market Maker Obligation (MMO) providing all participants with continuous opportunities to trade forward products. Financial products providing hedges against spot price volatility Although most current EU markets do not yet have financial products to hedge against large price volatility, such products may develop naturally when price volatility increases (e.g. Cap Future introduced by EEX in September 2015) In Australia such hedging contracts have naturally emerged. Cap contract provides a hedge against the price spikes. If the spot price exceeds this strike price (typically $300/MWh), the seller of the cap contract (usually a generator) must pay to the buyer of the cap contract (usually a retailer) the difference between the actual spot price and the strike price. In return, the buyer of the cap will pay the seller a fee, which provides the generator with an extra source of revenue. Forward financial transmission rights Increased granularity of locational prices may require hedging between the multi-zonal hub price and trhe spot price in individual zones or nodes. Such hedges are typically provided by Financial Transmission Rights www.iea-retd.org 26

5. Vertically integrated utility www.iea-retd.org 27

Vertically integrated utility Presentation of the prototype In markets where the incumbent is a vertically integrated utility: The incumbent has social obligations security of supply Generation is regulated Independent Power Producers may be allowed Dispatch and generation investment decisions are centralised Vertically integrated system in South Africa The state power utility, Eskom Holdings limited suppliers 96.7% of electricity in South Africa Eskom handles all functions of generation, transmission and distribution and is the single buyer from Independent Power Producers Hydroelectric, wind and solar power supply 0.5% of energy in the country Increasing renewable capacity in recent years South Africa places bids to build more wind power plants Vertically integrated utilities in United States A number of US states supplied by electricity via vertically integrated utilities The Western North America electric grid is managed by 37 Balancing Authorities Balancing Authorities in other states are vertically integrated utilities (Arizona, Colorado, New Mexico) The BAs are responsible for dispatching generation, procuring power, operating the transmission grid and maintaining adequate reserves www.iea-retd.org 28

Vertically integrated utility Critical elements of benchmark market design Element of market design Regulatory framework Rules for the third-party access Cross border trading arrangements Challenge presented by VRE Achieving the optimal generation mix under the decarbonisation constraints Operational timeframe shift towards real-time System stability through ancillary services and demand response The shift of operational timeframe to real-time Benchmark market design elements Ensure efficient investment, including renewable, with no undue rent transfers through regulatory mechanisms incentives for efficient development of VRE, distributed generation, energy efficiency and flexible generation both by the incumbent and by IPPs adequate return on investment and avoid incentives to over-invest No discrimination against IPP s for the short-term dispatch Efficient IPP s investment (timing and location) Ensure efficient short-term trade with neighbouring utilities Introduce bilateral and or organised energy cross-border trading May require reforms in the direction of those in the Energy Only prototype www.iea-retd.org 29

6. Hybrid market www.iea-retd.org 30

Hybrid market Presentation of the prototype What is the hybrid prototype? Dispatch decisions remain based on wholesale power prices But capacity investment decisions are supplemented by additional mandatory risk transfer or coordination mechanisms induced by the policy maker. Hybrid models vary widely depending on the objective and type of public intervention. Case study: hybrid market in Brazil The market reform of early 2000s introduced a hybrid markets, with long-term contracts being implemented to support and coordinate investment. The key objectives of the reforms were firstly to introduce better incentives for investment and secondly to guarantee that there would be enough capacity to meet the growing load in the future. Case study: hybrid market in Ontario Ontario government has introducing the Single Buyer model in 2004. Ontario Power Authority (OPA) acts as a single buyer and is responsible for long term forecasting and procurement of capacity by signing long-term contracts with power generators Case study: hybrid market in United Kingdom The Electricity Market Reform (EMR) introduced several hybrid mechanisms to support the market and provide incentives for investment in clean and conventional technology. Long-term contracts in the form of feed-in tariffs with contracts for difference Capacity mechanisms including long tenor capacity agreements www.iea-retd.org 31

Hybrid market Critical elements of benchmark market design Element of market design Challenge presented by VRE Benchmark market design elements Integrated resource planning Interface between centralised and decentralised processes Organisation of mandatory risk hedging instruments Increasing distance between generation and consumption Increased capital intensity and price variability Shift of the thermal plants towards mid- and peakload Shift of the operational timeframe to real-time New requirements for AS products, and new constraints to provide them Efficient resource planning and procurement process Transparent process for determination of investment needs Transparent and non-discriminatory process for tendering and allocation to third parties Ensure the state driven processes do not distort the short-term price signals required for flexibility resources Avoid rolling the short-term products into the capacity contracts Ensure the capacity contracts do not prevent the incentives for efficient short-term operation Induce efficient investment in all types of capacity coordinated with network development Shift of the thermal plants Induce the optimal volume of capacity including volume of VRE towards mid- and peakload consistent with the social cost of emission to the society Ensure that for each technology the contracts reward the specific Decentralised and value that this technology provides to the system scattered generation Allow coordinating the investment in generation with the existing and future transmission and distribution networks www.iea-retd.org 32

Hybrid market Integrated resource planning International experience with hybrid markets shows that designing an efficient hybrid market with complementary mechanisms to support system planning and allocate risk efficiently requires: A clear definition of roles and responsibilities Responsibilities and independence of the agency in charge of the planning and coordination mechanisms is the key In Latin America such responsibility is given to the ministry or to an agency which has strong ties with the government. In the UK delivery of the Electricity Market Reform (EMR) is conferred to the TSO (National Grid) Addressing inherent issues of a central planning process Planning agencies and system operators have an incentive to over-procure generation compared to the socially optimum level, especially in presence of VRE, which makes it difficult for the central planner to assess the expected production of wind and solar. This is one of the critics of the Ontario single buyer that has been made recently as over the last few years Ontario s retail prices have risen significantly. Planning process can be decentralized and moved to the level of individual suppliers, who may have more accurate information on the forecasted demand of its customers. The experience of Chile demonstrates that decentralised obligations on suppliers to contract generation in the long term can avoid some of the usual pitfalls of the central planning. In Europe, the French capacity market proceeds with a similar decentralised approach relying on obligations on suppliers. www.iea-retd.org 33

Hybrid market Interface between centralised and decentralised process Market distortions: Difficulties internationally designing an efficient interface that works in the short-term and long-term Distortions of energy market dynamics should be avoided OPA payments (Ontario): Generators bid energy into the spot market clearing mechanism that determines optimal dispatch and price Payments based on long-term contracts and spot market revenues OPA payment to generators www.iea-retd.org 34

Hybrid market Organisation of mandatory risk hedging instruments In Hybrid models long-term contracts led by state requirements support investment Efficient contract provision achieved by auction Difficulties designing procurement process New renewable capacity in Brazil is procured through technology-neutral auctions Auction process varies between countries may be centralised or decentralised Brazilian auction prices by technology www.iea-retd.org 35

7. Prosumer market www.iea-retd.org 36

Prosumer market Presentation of the prototype What is a Prosumer prototype? A power system in which a significant share of generators is located with consumers. These could be households, services, or industry that produce and consume electricity on site. Prosumers exist at large scale (industry) to very small scale (households). Large number of prosumers, owner structure is scattered Prosumers engage in auto-generation or self-consumption of electricity Prosumer development in Germany Strong growth in wind and solar power in last 20 years 21% of final consumption in 2015 Small-scale solar PV remains a niche Industrial auto-generation has existed since the early 1990s but declined in the early 2000s, before recovering in recent years Prosumer development on other selected markets Public policy debates have taken place in recent years in jurisdictions worldwide (Germany, Australia, California) Australians generate c.4x more electricity from small-scale solar compared to Germany www.iea-retd.org 37

Prosumer market Critical elements of benchmark market design Element of market design Retail pricing and metering rules DSO regulation Distribution grid coordination Market access Challenge presented by VRE Investment incentives visà-vis large-scale (RES) investments Incentives aligned with system needs Income base erosion Large investments in distribution grids required Unconventional solutions likely to be cost-efficient Risk of local hotspots that require massive distribution grid investments Elements of a benchmark market design Acknowledge the new role of retail prices: not only cost recovery, also generation and investment incentives Opt 1: finance certain retail price components from other sources (capacity-based fees, general budget,...) Opt 2: tax self-consumed electricity as well Coordinate distribution grid and generation investments to incentivize investment and innovation Opt 1: cost-reflective grid fees (connection and/or usage) Opt 2: zoning for distributed generation investments Design distribution network to reflect the existing constraints and the costs of grid expansion Prevent excessive costs for distribution grid upgrades in VRE hotspots where VRE development happens in a very concentrated manner Locate VRE generation where benefits for the grid are greatest, rather than cheapest Excessive transaction costs Provide market access: consider risk and transaction costs for small prosumers Market access risk Opt 1: single-buyer model should not be the SO Unfair distribution of Opt 2: competing aggregators, prosumers can choose balancing costs; lack of Opt 3: aggregators + market access of last resort incentive to improve Balancing and pricing rules should be size-neutral forecasts www.iea-retd.org 38

Prosumer market Retail pricing and metering rules The problem Consumers make consumption and investment decisions based on price signals they receive through retail electricity tariffs, rather than wholesale electricity prices. Prosumers avoid paying (some) taxes, fees, levies This causes three problems Investment incentives might be distorted vis-à-vis non-prosumer investments Prices might fail to signal system needs; The income of governments and system operators might decline The proposed solutions Grid tariff structure should reflect true costs of grid (fixed vs. variable cost) Option 1: other finance sources free the retail electricity price from its role as a collection mechanism for government and system operator income Option 2: tax all electricity consumed also auto-generated electricity Both options are problematic for reasons ranging from energy efficiency incentives to legal issues www.iea-retd.org 39

Prosumer market DSO regulation The problem Decentralised generation can dramatically increase the need for distribution grid upgrades Grid expansion costs can be significantly reduced in smart technology and smart planning procedures are applied Traditional incentive regulation does not provide appropriate incentives for investments or smart investments The proposed solutions A regulatory framework that provides such incentives E.g., the British performance-based RIIO framework ( revenue = incentives + innovation + outputs ) www.iea-retd.org 40

Prosumer market Distributed grid coordination The problem An important means to contain distribution grid expansion cost is to coordinate generation and grid investments Prosumers need to be provided with a signal where investments are preferable from a grid perspective Retail prices seldom provide such signals The proposed solutions A theoretical clean-cut solution would be dynamic locational marginal prices in distribution networks but this is likely to cause excessive transaction costs, even in the very long run Proxy signals include the following: Curtailment rules. Limit peak in-feed in clusters of decentralized generators in order to reduce stress on distribution grids Zoning. Zoning refers to the idea to address such regional differences by establish geographic zones where different rules apply: grids that are close to its limits could be closed for additional investments while others could remain open. Static price signals, for example in the form of (deep) grid connection or grid usage fees. www.iea-retd.org 41

Prosumer market Market access The problem Large number of small generators Traditional form of wholesale market access (own trading desks, direct access to power exchanges) is infeasible Appropriate balancing rules for prosumers Possible solutions Entry barrier-free balancing market Full balancing responsibility The single buyer model, where a central entity sells all decentralized produced electricity to wholesale markets. The aggregator model, where different aggregators compete and prosumers can choose among them. An aggregator model fosters innovation via competition and might enable flexibility by providing efficient spot dispatch signals and market access to ancillary services. Best of two worlds: competition among aggregators with aggregator of last resort www.iea-retd.org 42

8. Policy recommendations www.iea-retd.org 43

High-level policy recommendations Recommendations for short term system operation Remove barriers to scarcity pricing Create a level playing field and foster the development of flexibility in its various forms Introduce locational signals to coordinate decentralised players Introduce new risk hedging and risk transfer mechanisms to hedge price volatility induced by VRE Recommendations for optimal system development/ investment Reinvent coordination mechanisms for the decision on siting and timing of investment Modify the regulatory framework to drive efficient and timely development of the infrastructure necessary to integrate large shares of VRE Introduce policies for efficient risk transfer and risk hedging to ensure financeability of capital intensive technologies and to reduce the cost of capital. In case such hedging products do not develop naturally, policy makers may consider introducing hedging/contracting obligations. Recommendations on governance and regulatory framework Introduce policies supporting innovation in market design and the regulatory framework, e.g. regulatory framework for transmission and distribution operators. The governance of the market design and regulatory framework needs to enable a greater adaptability and will need to be reformed to ensure an efficient allocation of responsibilities. This may require revisiting the role of the TSO / ISO, as well as the interface and responsibilities of the TSO and DSOs. www.iea-retd.org 44

Recommendations for wholesale market design Energy-only policy recommendations Implement market design elements ensuring accuracy of short-term price signals Introduce locational price signals Develop hedging products Harmonise market designs across time frames Increase price caps and remove barriers to scarcity pricing Market power monitoring Improve balancing markets Improve the operating reserve markets Introduce geographical price differentiation through Zonal splitting Nodal prices Other location signals, e.g. locational connection charges, locational loss charges, etc. Geographical differentiation of balancing prices Introduce measures to improve opportunities for voluntary forward hedging Let the market demand for hedging develop as the intensity of price spikes increases Allow DSR participation in all market segments www.iea-retd.org 45

Recommendations for wholesale market design Vertically integrated system recommendations Adopt an efficient regulatory framework Apply transparent and nondiscriminatory rules for thirdparty access Facilitate cross-border trading arrangements Implement incentive regulation to foster deployment of low carbon technologies and support the development of the enabling infrastructure, Possibly delegate the planning role to a neutral third party. Apply transparent and nondiscriminatory rules for third-party access. Possibly, delegate thirdparty connection and dispatch roles to a neutral agency. Implement regulation and legal frameworks allowing bilateral cooperation on trading. Develop regional cooperation to ensure secure operation through a regional coordination agency www.iea-retd.org 46

Significant Limited Recommendations for wholesale market design Engineering the transition to hybrid approaches Challenges presented by high-vre on market designs may require the introduction of hybrid system elements, combining the centralised and decentralised approaches to the short-term and long-term decision making. Policy maker s intervention The degree of a policy-maker s intervention and the resulting tendency for centralised solutions. This is determined by policy-maker s attitude to risk and information asymmetry Transition to hybrid approaches under two drivers Hybrid capacity remuneration mechanism (CRM) focused on security of supply Policy-maker s intervention Advanced energy-only market Technology development of flexibility The development of the generation mix along the decarbonisation path leading to high shares of VRE, especially the flexibility of the mix Slow Hybrid investment market focused on specific technologies Hybrid technology neutral investment market Rapid Technology development of flexibility A mix with higher flexibility reduces the urgency of market design challenges presented by VRE and smooths the transition of the market design. Source: FTI-Cl Energy and NEON www.iea-retd.org 47

Recommendations for wholesale market design Hybrid approach policy recommendations Ensure efficient integrated resource planning Carefully design the interface between centralised and decentralised processes Award mandatory risk hedging contracts through transparent auctions Efficient resource planning and procurement process. Transparent process for determination of investment needs. Efficient governance and incentives of the planning agency. Design products to allow and encourage participation of renewables Ensure product definition and procurement process remunerates capacity irrespectively of the plant s output and short-term operations. Award the risk-hedging contracts through a transparent auction-based procurement process. Design auctions procurement processes so that they encourage participation of renewables and demand response providers. Account for specificities of RES cost structure to design mandatory hedging contracts that allow an efficient risk allocation and support capital intensive investments. Favour a decentralised procurement to allow contracts to be tailored to meet the specific needs of suppliers and capacity providers. www.iea-retd.org 48

Low Intense Recommendation for retail market design Transition to the prosumer market The type of prosumer development could be very different depending on two drivers Prosumer attitude Many factors might increase the intrinsic interest of consumers in electricity generation, such as: status and life-style the gamification of energy supply an early adopter attitude towards energy technology the positive image associated with auto-generation Commodity vs service The transition to a power sector with a high share of VRE could reduce the importance of energy commodity prices and transform the retail energy supply into a serviceoriented good, rather than a commodity Transition to the prosumer market Prosumers attitude/ engagement Prosumer market with consistent retail/wholesale price Commodity Prosumer market with dissociated wholesale and retail markets Self-consumption as part of the energy service bundle Services Difficult to induce direct participation of prosumers Pricing and consumption of electricity Source: FTI-Cl Energy and NEON www.iea-retd.org 49

Recommendation for retail market design Prosumer market recommendations Adapt retail pricing and metering rules to provide investment incentive Redesign regulation of DSOs with focus on (smart) investments Provide locational signals to investors within distribution grids Provide market access and apply balancing responsibility Make sure the prices that prosumers and nonprosumers face should be aligned. DSO regulation should provide incentives for efficient large-scale investments. Introduce retail price geographical differentiation at the level of the distribution grid. Ensure low-cost access to wholesale and ancillary service markets for prosumers. Apply taxes and charges to selfconsumed electricity or by cleaning up the electricity bill. It should stimulate innovative solutions such as demand response, or storage Differentiated retail price signals should give prosumers investment signals to coordinate with grid constraints and grid upgrade requirements. Foster aggregator competition while keeping a market access of last resort to avoid excessive risks. www.iea-retd.org 50

THANK YOU! For more information: David de Jager david.de.jager@iea-retd.org