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Electricity Market Design and RE Deployment
RES-E-MARKETS
September 2016
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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
Content
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1. Context and methodology
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FTI Consulting is a multidisciplinary international internationalconsulting company. Neon is a specialised consulting boutique
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
Neon Consulting activityFTI Consulting activity
INTERNATIONAL SCOPEOver 4,200 professionals in 24 countries on 6 continents
PROFESSIONAL EXPERTISEReputable consultants in a variety of domainswith respect to international clients
ENERGY EXPERTISE FTI-CL Energy experts have advancedexpertise in the issues of electricity marketdesign
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• 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)
Project context: Toward high shares of renewables in the generation mix
Source: IEA (2014): Energy technology perspectives, 2DS scenario.
The share of variable renewables (VRE) in electricity generation in selected regions
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• These challenges will play out differently depending on the power system organisation:
• In jurisdictions with liberalised power sector: growing concern that competitive wholesale markets co-existing 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
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
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
Source: FTI-Cl Energy and NEON
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Our approach: from the ideal market design towardtransition pathways
Project phases
InceptionA variety of current market
designs Clustered case studies
Task 1Prototypes
and blueprints
Task 2Transition pathways
Task 3Policy
recommandations
Markets time scale
Methods
• Spot markets
• Ancillary services
• Int’l market integration
• Reducing political risks
• ...
Policy making as a search process:gradual adjustments, stakeholder involvement, learning
time /VRE share
2015 2016-2020 2020-2050 2050
Literature reviews
Bilateral interviews
Case study analysis
Workshop
Analytical framework of Task 1 may be adjusted as a result of the results in Task 2 and 3
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2. A theoretical framework for market design assessment
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• Market design shapes the incentives under which all these decisions are taken
• 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.
The wide scope of market design and policy frameworks
Governance and institutional framework (roles of policy, independent regulator, etc.)
Infrastructure regulation (transmission, distribution)
RES support
Retail market
Balancing and ancillary services
Wholesale market
Source: FTI-Cl Energy and NEON
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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
• 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
• Hybrids• Most markets still hybrids with some form of
regulatory intervention• Public intervention differs depending on
objective, type of intervention and risk allocation
Short-
term
dispatch
Long-term
investment planning
Wholesale market with
a capacity mechanism
Investment markets
with tenders for
long-term contracts
Hybrid
approachesDecen
tralised
Cen
tralised
Centralised Decentralised
Energy-only
Vertically integrated
Source: FTI-Cl Energy and NEON
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Criteria for ideal market design with high level of VRE
Economic welfare
Efficientdispatch
Efficientinvestment
Appropriaterisk
allocation
Appropriaterent
allocation
Dispatch signals
Ancillary services
Geographical co-ordination
Pricingexternalities
Investment signals
Coherence short/long-term
RES support schemes
Locational signals
Appropriate risk allocation
Minimizing financing costs
Robust to market power
Stranded assets management
Environmental externality
Ultimate goal
High-level criteria
Specific criteria
Reducing policy risk
Innovation incentives
Power system externalities
Interface with other sectors
Policy objectives Operational constraints Wider energy systemConstraints
1 2 3 4 5
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The diversity of power systems and implications for market design
Vertically integrated monopolist
Vertically integrated monopolist + IPPs
Source: FTI-CL Energy analysis based on various sources including World Bank
Power market of gencos, discos and large users, transco and ISO
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
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• 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
Stylized models of power system organization: 4 different prototypes
Energy-onlyVertically
integratedHybrid Prosumer
Dispatch
decisions
Decentralised
through wholesale
market prices
Centralised based
on costs and other
drivers
Decentralised
through wholesale
market prices
Decentralised
through retail
market prices
Investment
generation
Decentralised
through wholesale
market prices
Centralised based
on planning
Centralised based
on planning
and/or risk sharing
mechanism
Decentralised
through retail
market prices
Examples
Texas , Australia,
Europe
South Africa, US Brazil, UK Germany,
Australia,
California
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3. Key challenges for power system with high shares of VRE
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Three main challenges of VRE to power systems and market design
• 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
• Trade-off between policy flexibility and regulatory risk
• 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 intra-day
• Assurance of system stability
• Need for new AS products, e.g. providing system inertia
• Redesign AS to allow VRE participation
• 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
• Many small producers need access to wholesale markets
Capital intensityLimited predictability and
variabilityDecentralized and scattered
generation
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Wholesale market challenges: Future production mix and the system marginal cost
Modelled price duration curve in ETP scenario, 2050
Source: IEA 2015 RE-POWERING MARKETS
• 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
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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.
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4. Energy Only market
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• 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
Energy Only marketPresentation of the prototype
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Energy Only marketCritical elements of benchmark market design
Element of
market design
Challenge presented by
VREBenchmark 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 pricesCredible scarcity pricing• Scarcity pricing mechanisms based on operating reserve demand curves• Non-distortive market power and manipulation legislationEfficient 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
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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.
Energy Only marketDesign of the energy and ancillary services markets
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• 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.
Operating reserves demand curve in Texas
Average daily pool prices in NEM, 2003-2011
Energy Only marketCredible scarcity pricing
Source: Riesz, J, 2013, “Will Australia’s energy-only market work with high renewables?”
Source: Potomac Economics, 2015, ERCOT State of the Market report, 2014
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• 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
Energy Only marketDemand-side participation
Source: FTI-CL Energy, 2015, “Toward the Target Model 2.0: Policy Recommendations for a Sustainable EU Power Market Framework”
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• 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.
• 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.
Relationship between the reserve cost and the electricity spot price
Energy Only marketEfficient valuation of ancillary services and reserves
Source: Hirth & Ziegenhagen (2015): Balancing power and variable renewables
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• 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)
• 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
Nodal day-ahead price differences in Texas
Energy Only marketLocational price signals
Source: ERCOT
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• 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 trhespot price in individual zones or nodes.
• Such hedges are typically provided by Financial Transmission Rights
Energy Only marketDevelopment of hedging products
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5. Vertically integrated utility
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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
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
Vertically integrated system in South Africa Vertically integrated utilities in United States
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 utility
Presentation of the prototype
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Vertically integrated utilityCritical elements of benchmark market design
Element of
market
design
Challenge presented by
VREBenchmark market design elements
Regulatory
framework
• Achieving the optimalgeneration mix under the decarbonisationconstraints
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
Rules for the
third-party
access
• Operational timeframe shift towards real-time
• System stability through ancillary services and demand response
No discrimination against IPP’s for the short-term dispatch
Efficient IPP’s investment (timing and location)
Cross border
trading
arrangements
• The shift of operational timeframe to real-time
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
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6. Hybrid market
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• 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
Hybrid marketPresentation of the prototype
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Hybrid marketCritical elements of benchmark market design
Element of
market design
Challenge presented by
VREBenchmark market design elements
Integrated resource planning
• Increasing distance between generation and consumption
• Increased capital intensity and price variability
• Shift of the thermal plants towards mid- and peak-load
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
Interface
between
centralised
and
decentralised
processes
• Shift of the operational timeframe to real-time
• New requirements for AS products, and new constraints to provide them
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
Organisation
of mandatory
risk hedging
instruments
• Shift of the thermal plants towards mid- and peak-load
• Decentralised and scattered generation
Induce efficient investment in all types of capacity coordinated with network development• Induce the optimal volume of capacity including volume of VRE
consistent with the social cost of emission to the society• Ensure that for each technology the contracts reward the specific
value that this technology provides to the system• Allow coordinating the investment in generation with the existing and
future transmission and distribution networks
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• 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.
Hybrid marketIntegrated resource planning
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• 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
Hybrid marketInterface between centralised and decentralised process
OPA payment to generators
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• 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
Hybrid marketOrganisation of mandatory risk hedging instruments
Brazilian auction prices by technology
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7. Prosumer market
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• 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 marketPresentation of the prototype
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
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
Prosumer development in Germany Prosumer development on other selected markets
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Prosumer marketCritical elements of benchmark market design
Element of
market design
Challenge presented by
VRE
Elements of a
benchmark market design
Retail pricing
and metering
rules
• Investment incentives vis-à-vis large-scale (RES) investments
• Incentives aligned with system needs
• Income base erosion
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
DSO
regulation
• Large investments in distribution grids required
• Unconventional solutions likely to be cost-efficient
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
Distribution
grid
coordination
• Risk of local “hotspots”
that require massive
distribution grid
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
Market access
• Excessive transaction costs
for small prosumers
• Market access risk
• Unfair distribution of
balancing costs; lack of
incentive to improve
forecasts
Provide market access: consider risk and transaction costs
• Opt 1: single-buyer model– should not be the SO
• Opt 2: competing aggregators, prosumers can choose
• Opt 3: aggregators + “market access of last resort”
• Balancing and pricing rules should be size-neutral
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• 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
Prosumer market
Retail pricing and metering rules
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• 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”)
Prosumer market
DSO regulation
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• 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.
Prosumer market
Distributed grid coordination
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• 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”
Prosumer market
Market access
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8. Policy recommendations
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• 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.
High-level policy recommendations
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Recommendations for wholesale market design
Energy-only policy recommendations
• 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
• Allow DSR participation in all market segments
• 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
Implement market design elements ensuring accuracy of
short-term price signals
Introduce locational price signals
Develop hedging products
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• 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 non-discriminatory rules for third-party access.
• Possibly, delegate third-party 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
Adopt an efficient regulatory framework
Apply transparent and non-discriminatory rules for third-
party access
Facilitate cross-border trading arrangements
Recommendations for wholesale market design
Vertically integrated system recommendations
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• 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
• 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
• A mix with higher flexibility reduces the urgency of market design challenges presented by VRE and smooths the transition of the market design.
Recommendations for wholesale market design
Engineering the transition to hybrid approaches
Transition to hybrid approaches under two drivers
Hybrid – capacity
remuneration mechanism
(CRM)
focused on security of
supply
Advanced energy-only
market
Hybrid – investment
market
focused on specific
technologies
Hybrid – technology
neutral
investment market
Technology –
development
of flexibility
Policy-maker’s
intervention
Slow Rapid
Lim
ited
Sig
nif
ican
t
Source: FTI-Cl Energy and NEON
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Recommendations for wholesale market design
Hybrid approach policy recommendations
• 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.
• Account for specificities of RES cost structure to design mandatory hedging contracts that allow an efficient risk allocation and support capital intensive investments.
• 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.
• Favour a decentralised procurement to allow contracts to be tailored to meet the specific needs of suppliers and capacity providers.
Ensure efficient integrated resource planning
Carefully design the interface between centralised and decentralised processes
Award mandatory risk hedging contracts through
transparent auctions
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• 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 service-oriented good, rather than a commodity
Recommendation for retail market design
Transition to the prosumer market
Transition to the prosumer market
Prosumer market with
consistent
retail/wholesale price
Self-consumption as
part of the energy
service bundle
Prosumer market with
dissociated wholesale
and retail markets
Difficult to induce
direct participation of
prosumers
Prosumers attitude/
engagement
Pricing and
consumption
of electricity
Commodity Services
Inte
nse
Lo
w
Source: FTI-Cl Energy and NEON
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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 non-prosumers face should be aligned.
• Apply taxes and charges to self-consumed electricity
■or by cleaning up the electricity bill.
• DSO regulation should provide incentives for efficient large-scale investments.
• It should stimulate innovative solutions such as demand response, or storage
• Introduce retail price geographical differentiation at the level of the distribution grid.
• Differentiated retail price signals should give prosumers investment signals to coordinate with grid constraints and grid upgrade requirements.
• Ensure low-cost access to wholesale and ancillary service markets for prosumers.
• Foster aggregator competition while keeping a “market access of last resort” to avoid excessive risks.
