Re-Powering: Improving the electricity market framework for the transition to a low-carbon power system

The Paris Agreement is now on track to enter into force with dozens of countries, including the biggest carbon emitters, having now formally ratified it. Delivering on the ambitious objectives that most countries have agreed to requires strong policy actions as many will have to “re-invent” their electricity markets.
Already, electricity markets are undergoing massive transformation, as the push for low-carbon power generation shifts the industry towards higher investment in renewables and other new technologies even as demand stagnates or declines in many places, including in the EU. The next step will be ensuring that market frameworks evolve to take into account these low carbon technologies.
To accelerate this process and inform policymakers of the associated challenges and opportunities, the IEA recently published “Re-powering Markets: Market design and regulation during the transition to low-carbon power systems.*1 Drawing on the Agency’s review of best practices in electricity market design, mainly in Europe, the United States and Australia, it offers guidance to governments, regulators, and investors on how to move to low-carbon generation in an economic way while ensuring the security of electricity supply.

Re-powering refers to the process of replacing older power stations with more efficient, cleaner, and more powerful ones.

But the term also applies to the evolution of market design whereby older market frameworks are replaced with new ones suitable for decarbonisation. Given the growing importance of wind and solar power, market rules must develop along with the flexibility of the power system.

Improving the market framework for decarbonisation
Much of the transformation will take place in competitive market environments already introduced to varying degrees around the world. Building the electricity markets of the future requires a comprehensive framework that encourages low-carbon investments and operational efficiency while also keeping security of supply as a top priority.
Existing markets rules need to be modernized to unlock the flexibility necessary to deal with the variability of renewables. Markets are adopting technology that allows pricing of electricity in day-ahead, intraday and realtime. More has to be done to provide detailed and transparent prices to communicate the cost of electricity in specific locations and circumstances. Decarbonisation relies extensively on small scale wind and solar plants and distributed generation, battery storage and demand response. Transparent market prices are increasingly needed at the local and distribution level.
Beyond the falling costs of wind and solar power, the market value of electricity produced increasingly matters as the share of renewables increases. Low-carbon generators need to participate in electricity markets as they can and should earn a high fraction of their revenues there. Market participation provides important signals, revealing the value of different low-carbon technologies. This will ultimately help mitigate the risk of investing in the wrong technologies deployed in the wrong places.

A new balance between regulation and competitive markets needed
Besides efficient markets, the shift to a low- carbon energy system requires a carbon price
to help determine the appropriate value for various technologies. But introducing a sufficient carbon price will take time and the energy transition is urgent. The window of opportunity to stay on track with a 2C degrees target is rapidly closing and the risk of locking in unsustainable infrastructure remains high.
Given electricity market prices today, long-term arrangements backed by governments remain necessary to attract sufficient levels of low-carbon power generation, at least during the transition period. Low carbon is capital intensive and requires long-term visibility to mitigate risks for investors, in particular the regulatory risk and carbon price risk, and to keep financing costs lower.
Networks are also critical. Improving and expanding power grids, including across borders, will help ensure the integration of wind and solar power as well as increasing electricity security. Proper governance is necessary to see the bigger, often transnational, picture critical to a modern electricity system.

Ensuring electricity security
Security of electricity supply remains a key concern for governments and other stakeholders. As markets evolve, shortages of capacity can result in scarcity prices. While these prices are critical to incentivise generators to produce more power and get consumers to reduce demand, there is a clear need for an adequate regulatory framework during hours of capacity shortage.
In addition to looking at price spikes, most markets are using targeted capacity mechanisms in one form or another. They create a safety net for maintaining adequate generation to meet reliability standards in a context of huge uncertainty of decarbonisation pathways. Such mechanisms have widespread impacts and need to be well-designed to avoid inefficiency.

Leading the clean energy transformation
In the end, there is no one single market design for the low-carbon energy systems of the future. As new technologies prompt constant evolution, governments and industry around the world must adjust. The IEA, with its long history of expertise in electricity markets, will continue to analyse the possible, cost effective and secure pathways to this transition to provide different options to policymakers to design their own markets.