European Commission building in Brussels (photo Sam Barnett)
To address the crisis in the EU power sector, the European Commission has embarked on a fundamental reform process – the Market Design Initiative. However, according to Michael Hogan, Senior Advisor at the Regulatory Assistance Project (RAP), the problem with the EU power sector today is not so much market design as a glut of old, inflexible baseload generation.
The European Commission’s Market Design Initiative (MDI), launched in July last year, rightly identifies investment and security of supply, demand-side participation in markets, and market governance as three central pillars of a successful market reform. In framing the initiative’s priorities, however, the Commission has neglected some of the most important obstacles to success in each of these three critical areas.
With the exception of a few pockets isolated by inadequate transmission, Europe’s power sector is drowning under a glut of production capacity
Investment and security of supply
The principal cause of the financial woes plaguing the power sector is not market design. It is rather a glut of old, inflexible baseload generation—primarily, but not exclusively coal-fired—that is surplus to requirements and incompatible with the power system’s growing need for more flexible resources.
The glut of old, inflexible baseload generation is surplus to requirements and incompatible with the power system’s growing need for more flexible resources.
The idea that we should “re-design” the power market springs in part from the perception that the market is failing to support investment needed “to keep the lights on.” On closer inspection, however, it becomes clear that this diagnosis misses the mark. With the exception of a few pockets isolated by inadequate transmission, Europe’s power sector is drowning under a glut of production capacity, and not just any production capacity. The problem is inflexible baseload.
Wholesale and retail markets—and even in some cases national legislation—are rife with provisions that needlessly discriminate in favour of large generators
Hence, the top priority in restoring a healthy investment climate to the power sector should be a targeted, “smart” programme for permanently retiring inflexible, old baseload plants as quickly as they become surplus to requirements. To support this, a new, regional, independent framework for assessing generation adequacy must be created—one that fairly accounts for all resources, including energy efficiency, demand response, storage, and interconnection.
Demand-side participation in markets
“Empowering European consumers” is a rallying cry of the MDI and rightly so. Demand participation is not only essential for the market to work, it is a critical success factor for the energy transition. But the suggestions for action so far fall well short of what it will take to make this happen.
Getting price signals right is crucial, and the MDI can go much farther in challenging Member State interventions, such as capacity markets, that distort the information provided by energy market prices. If intervention to support investment is deemed necessary, it should first enhance rather than undercut the effectiveness of energy market prices. But better price signals are only a start:
- Wholesale and retail markets—and even in some cases national legislation—are rife with provisions that needlessly discriminate in favour of large generators.
- New entry by innovative players is inhibited by ineffective market monitoring and enforcement.
- Decarbonisation of the heat and transport sectors is expected to rely heavily on electrification, and yet the strategies for those new sources of electric demand are being developed without adequate coordination with power market strategies.
These problems can be addressed through various measures, e.g. jump-starting demand’s role in markets, including time-of-use tariffs, especially for transport and heating and cooling applications, “smart appliance” standards, support for building grid-integrated thermal energy storage into heating and cooling applications, and limited supplier obligations.
Market governance
No market design can succeed without effective governance. While the MDI refers to the need for a more regional and European approach to market governance, it overlooks the most glaring obstacle to success—the widely held and largely justified belief that the market is not competitive.
It would be foolish to expect any market design to succeed unless the conditions necessary for success are in place. From the wholesale to the retail level, consumers, regulators, and government must have confidence that they are not going to be exploited by a few large, incumbent generators and suppliers.
Europe has yet to develop the kind of robust market monitoring, reporting, and enforcement framework that underpins successful electricity markets elsewhere in the world
Abuse of market power by established players can stifle the innovation and investment needed to overcome the challenges and seize the opportunities presented by the energy transition. Europe has yet to develop the kind of robust market monitoring, reporting, and enforcement framework that underpins successful electricity markets elsewhere in the world. The MDI must go farther in establishing an independent, expert, and fully resourced market monitoring and reporting function as well as clarifying and consolidating the competition enforcement regime. It must also provide coherence between energy and climate governance regimes by embedding energy-related climate objectives into energy market governance principles.
Implementation, governance and complementary policies critical to success
The European Commission has opened an important window of opportunity to address critical electricity market-related issues. While there is a temptation to focus on the design of the current market as the problem to be addressed, in fact it is the galaxy of implementation issues, governance structure, and complementary policy challenges that require the most urgent attention.
Editor’s Note
The Regulatory Assistance Project (RAP), a globally operating independent and nonpartisan team of experts. This article is based on a Policy Brief published by RAP in conjunction with E3G, ClientEarth, Energy Union Choices, Agora Energiewende, European Climate Foundation and IDDR in March 2016, Priorities for the Market Design Initiative: What’s Missing? What’s Most Important?
[adrotate group=”9″]
Thanks Michael
Coincidentally just posted these thoughts today about some similar challenges facing the energy market in Australia:
http://www.wattclarity.com.au/2016/04/what-happens-when-energy-is-free/
Paul
You argue that currently we are “drowning under a glut of production capacity …” and more specifically “inflexible baseload”. Supposedly the post figure should support the argument. However, both the figure and the argument are seriously misleading.
Firstly, the figure. Peak demand is plotted versus installed capacity. Surprisingly fossil capacity is plotted in the upper side of the bars, and solar and wind in the middle part. However solar capacity is mostly irrelevant in terms of meeting peak demand, as peak demand happens in the evening after the Sun sets. Wind capacity must be likewise strongly de-rated to account for possible low availability (that is, wind possibly not blowing) during peak times. For instance, the Spanish TSO (REE) considers a derating factor of 7%, that is, just 7% of wind capacity is “firm capacity” that should be counted in order to meet peak demand. If you should interchange the “fossil” part of the bar with the “solar” and “wind” it would be obvious that capacity margins do not exhibit a growing trend. As economic activity recovers, demand will grow and capacity margin will further decrease.
Secondly, the argument. “Inflexible” baseload capacity is required in order to meet demand, although baseload energy is decreasing and will further decrease as renewables sources integrate in the system. Demand side measures, storage and more flexible resources will play a greater role in future. It is however needed to avoid as much as possible to build additional fossil capacity as these new technologies mature, and specifically to avoid lock-ins in new gas-fired power plants. Premature and forced retirement of “old” power plants may temporarily ease living to remaining thermal power plants, but at the cost of greater and unneeded investments in fossil capacity in the future. Rather, barriers of exit that prevent market driven closure of existing power plants should be lifted. “Old” power plants will close anyhow during the next decade, as their economic life ends, buying time for demand side solutions, storage and flexible renewable to develop.
I’d add to Juan’s critique of the graph that the author’s argument is not supported by lumping in coal plant, CCGT, OCGT, oil plant as “fossil fuel”. This combines the allegedly “inflexible baseload” with flexible peaking plant (as well as plant of intermediate characteristics. It would be more useful to categorise plant capacity as follows:
Baseload/inflexible (high utilisation, proportionally small ramp rates, e.g. nuclear, coal)
Flexible dispatchable (low utilisation, proportionally high ramp rate, e.g. some gas and oil fired plant, hydro)
Non-dispatchable (e.g. wind and solar).
I’m interested in how the incumbents manage to exercise market power when the system is “drowning under a glut of production capacity” – the two seem inconsistent.
I am curious as to the source of the statements in boxes – I followed the link to the market design initiative but is not clear if that is the source. It would be useful to have some supporting links/examples to back up these strong claims.
Please don’t waste time lecturing me on firm capacity credit and resource adequacy methodology – I was lectured on those topics by some of the pioneers in the field while you were still in high school. The graphic is deliberately simplified to make a point. Demand has risen only slightly since 2000 and yet generating capacity – fossil as well as renewable – has increased dramatically. Of course we’ve looked at some de-rating scenarios and not surprisingly the story remains the same. Even if you de-rate solar to 0% of installed capacity – too conservative but useful for illustration – and wind to 20% of installed capacity – more realistic, with some locations being lower and others higher – the system is still wallowing in surplus capacity and is forecast to be so at least through 2025. And those numbers ignore a huge percentage of the potential for demand response in EU markets. Given that, of course, your second argument falls apart. Since there is a considerable amount of overcapacity in the system, there is a glaring opportunity to retire high-carbon baseload plant, not only without any noticeable impact on reliability but with a beneficial effect on the remaining generation by lifting clearing prices to a more sensible level.
I’m afraid you’re trying to defend a hopeless position that doesn’t have a shred of credibility to it. I can understand that, given where you are, but no matter how loudly you proclaim that all the generation you’ve invested in is needed to “keep the lights on” it still isn’t true.