Although renewable energy installations have low operating costs, they have to recoup their high up-front investment costs over the course of their lifetime. Moreover, their returns are highly weather-dependent. They generate a lot of electricity at times when it is windy and sunny. While good for the energy supply, this intermittently high supply forces prices down and makes it unattractive for producers to feed electricity into the grid at these times. The electricity supply is also affected if there is not enough sunshine or wind. Reserve capacity is needed to guarantee security of supply during “dunkelflautes”. The current electricity market does not yet fully reflect these specific characteristics of renewable electricity.
In view of the above, the Academies’ Project ESYS (Energy Systems of the Future) – a joint initiative of acatech, Leopoldina and the Union of the German Academies of Sciences and Humanities – investigated how these problems can be addressed through reforms of the existing market design. The working group was co-chaired by Jürgen Kühling (Chair for Public Law, Real Estate Law, Infrastructure Law and Information Law at the University of Regensburg) and Justus Haucap (Heinrich Heine University, Duesseldorf Institute for Competition Economics). Its findings have now been published in the ESYS Position Paper “Creating Investment Incentives, Providing Reserve Capacity: options for the market integration of renewable energy”. The experts conclude that, even during the current crisis, there is no fundamental question about the effective functioning of the electricity market. Major interventions in the market are thus unnecessary. Nevertheless, they argue that reforms to the electricity market design are needed in order to enable a rapid transition to 100% renewable energy.
Enabling flexibility
The inflexible nature of generating electricity from renewable sources is at the root of the investment problems in the energy system. Consequently, the experts argue that the electricity system must become more flexible. This requirement underpins all the other reforms and can only be fulfilled through a combination of technological innovations and economic incentives. For example, storage systems, flexible demand and flexible additional capacity can reduce the need for additional installations, grid infrastructure and reserve capacity. The digitalisation of the electricity system, for example the rollout of smart meters, is also key in this context.
Targeted use of market premiums and incentives to provide reserve capacity
Building on this flexibility, the ESYS experts go on to identify carbon pricing as the most effective and cost-efficient long-term mechanism for achieving climate neutrality by 2045. The carbon price should increase within a defined corridor and should be extended to as many sectors as possible. However, they do not believe that this instrument will be enough on its own to meet the 2030 targets for the expansion of renewables. In the short term, they argue that carbon pricing will need to be supplemented by market premiums. The Position Paper compares the opportunities and risks of fixed and sliding market premiums and of Contracts for Difference, providing policymakers with a basis for choosing the most appropriate market premium model.
It will be necessary to carefully assess whether the current strategic reserve system will be enough to meet future requirements. At present, the combination of an energy-only market and backup power plants is able to guarantee the availability of adequate reserves. The experts identify central or decentralised capacity markets as an alternative to this model. These could create new investment incentives, making the provision of reserve capacity more attractive to the market.
