Deployment RES-E-MARKETS September 2016 Content 1. Context and - - PowerPoint PPT Presentation

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 international consulting 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 activity FTI Consulting activity

INTERNATIONAL SCOPE Over 4,200 professionals in 24 countries

• n 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

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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.

Th The e sha hare of

• f var

aria iable le re renewable les (V (VRE) ) in n el electric icit ity gen generatio ion in n sele elected re 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 toward transition pathways

Project phases Inception

A variety of current market designs Clustered case studies

Task 1

Prototypes and blueprints

Task 2

Transition pathways

Task 3

Policy recommandati

• ns

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 tim ime / VRE VRE shar 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
• bjective, 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 approaches

Decentralised Centralised 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

Efficient dispatch Efficient investment Appropriate risk allocation Appropriate rent allocation

Dispatch signals Ancillary services Geographical co-

• rdination

Pricing externalities

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

• ther sectors

Policy objectives Operational constraints Wider energy system

Constraints

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-only Vertically integrated Hybrid Prosumer

Dispatch decisions Decentralised through wholesale market prices Centralised based

• n costs and other

drivers Decentralised through wholesale market prices Decentralised through retail market prices Investment generation Decentralised through wholesale market prices Centralised based

• n planning

Centralised based

• n 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
• f 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 intensity Limited predictability and variability Decentralized 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 market Presentation of the prototype

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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 /

• ff-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 21 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 market Design 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 market Credible 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 market Demand-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 market Efficient 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 market Locational 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
• nly 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

Energy Only market Development 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 utility Critical elements of benchmark market design

Element of market design Challenge presented by VRE Benchmark market design elements Regulatory framework

• Achieving the optimal

generation mix under the decarbonisation constraints 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 market Presentation of the prototype

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Hybrid market Critical elements of benchmark market design

Element of market design Challenge presented by VRE Benchmark 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

• f 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
• bligations on suppliers.

Hybrid market Integrated 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 market Interface 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 market Organisation 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 market Presentation 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 market Critical 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

• f flexibility

Policy-maker’s intervention Slow Rapid Limited Significant 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

• utput and short-term
• perations.
• 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-

• riented 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

• f electricity

Commodity Services Intense Low 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

• f DSOs with focus
• n (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.

THANK YOU!

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