It’s time to redesign the world’s energy markets

Giles Parkinson at ReNewEconomy has a call to redesign the way energy markets work to handle the shift to renewable energy - It’s time to redesign the world’s energy markets.

The path from point A to point B in the de-carbonisation of the world’s electricity markets is looking more problematic by the day. Even as more people can see what the destination looks like, few are sure of the best path to get there.

More and more reports are being produced that demonstrate how the world’s biggest economies can be powered by renewable energy sources – essentially the wind and the sun. The EU has done its own scenario planning, as has the International Energy Agency and numerous other institutions and think-tanks, including Australia’s UNSW, the Melbourne Energy Institute, and Beyond Zero Emissions. The US-based National Renewable Energy Laboratory this week released a report showing how the world’s biggest economy could be powered 80 per cent by renewables by 2050. But the problem is how to manage that transition.

Most studies, such as the IEA’s, Desertec’s and NREL’s, talk of a “new paradigm” in energy markets. But it’s not just a new way of thinking. Some utilities who operate in these markets are more prosaic – fearing that these markets are effectively defunct because renewables redefine the rules on which these markets were built. Or, at least, they displace those that were previously favoured.

This is in reference to the merit order effect, which we have documented on numerous occasions, and which is now entering the broad lexicon of policy decision-making.

Australian utilities have a particular interest – although the merit order has impacted revenue and profits to a lesser extent than in Germany, the sort of penetration that is being envisaged by the world’s largest economies – and which will be demanded by consumers who can see that rooftop solar is a cheaper option that grid-connected power – could challenge, or even ruin, the business models of the incumbent fossil fuel generators.

In short, they are about to go through the same sort of revolution that is being experienced by the media industry disrupted by online publications. And no-one is too sure how to react, other than assuming and implementing a massive upheaval.

The German government – which has an ambitious renewables program to fill the gap left by nuclear – has recognized the issue, and called emergency talks to discuss what regulatory initiatives could be adopted to ensure that enough capacity remains in place to manage that transition.

This week Stadtwerke Leipzig, a local utility, noted that renewable energy is lowering power prices, but in doing so has left the country with a market whose design is no longer effective.

“As long as renewables have zero margin costs, the market design we have doesn’t work,” Jens Teresniak, team manager for business development and market analysis at Stadtwerke Leipzig, said in an interview in with Bloomberg. He said capacity markets, that allow utilities to fix prices for guaranteed backup power supply in advance will support margins for gas and coal electricity plants as renewables output rises, and could be the solution.

This is now being openly discussed among German policy makers – because major power producers are refusing to build new gas plant without it. It is even being discussed in Australia, although some wonder if a system that guarantees payment to generators whether they are producing or not, can be the most effective mechanism.

Germany electricity prices have fallen substantially and fell 18 per cent to 43.49 euros ($54.36) a megawatt-hour in the first five months of this year compared to last year, according to data from European Energy Exchange. Australian wholesale prices are also at record lows, hit by the impact of renewables, and lower demand.

“Renewables have shifted the merit order and now it’s like we have two different markets, one for renewables with 20 years’ guaranteed FIT, and one competitive for conventional power plants,” Thorsten Korner, the head of energy trading at Stadtwerke, told Bloomberg. “We have to think about integrating renewables and how we will organize 80 percent renewables on the grid by 2050.”

Meanwhile, the NREL study, a collaboration of 100 contributors from 35 organisations, laboratories, NGOs, corporates and universities, is being billed as the most comprehensive analysis yet undertaken of high-penetration renewable electricity in the US.

The bottom line conclusion was that it was possible, though challenging.

“Renewable electricity generation from technologies that are commercially available today, in combination with a portfolio of flexible electric system supply- and demand-side options, is more than adequate to supply 80 percent of total US electricity generation in 2050, while meeting electricity demand on an hourly basis in every region of the United States,” it said.

However, new sources from grid flexibility would be needed to manage the daily fluctuations from solar and wind generation, and this needed to come from a suite of supply- and demand-side options, including flexible conventional generation, grid storage, new transmission, more responsive loads, and changes in power system operations.

NREL estimates such a scenario would result in average annual retail electricity price increases of 0.8 per cen to 1.2 per cent – compared to around 0.3 per cent on the baseline scenario. But tis was based on technology costs estimated in 2010. Solar PV is already half its price then, and the costs are likely to be significantly lower than forecast.

The bottom line, however, is the need for a complete transformation of the current electricity system – including generation, transmission, and markets.

“This transformation, involving every element of the grid, from system planning through operation, would need to ensure adequate planning and operating reserves, increased flexibility of the electric system, and expanded multi-state transmission infrastructure,” it said. “And it would likely rely on the development and adoption of technology advances, new operating procedures, and evolved business models, market rules, and regulatory regimes.”

It is these institutional challenges that are among the biggest barriers to a decarbonised electricity supply. A lot more so than technology and cost.