What Kind of Market Design Is Needed for a Successful Energy Transition?#ZEWPodcast
ZEW Podcast with Marion Ott
The green energy transition is a top priority on the political agenda. As of now, however, it is highly uncertain whether policymakers will achieve their ambitious targets. On the supply side, but also in terms of grid expansion, there is currently a gap between proclaimed ambition and reality. So how will policymakers set the right incentives in future to ensure that the transition succeeds? And what happens if there is enough renewable energy but the grid is inadequate? In the latest episode of the #ZEWPodcast, market design expert Marion Ott provides answers to these questions and talks about what the energy market of tomorrow could look like.
In order to move forward with the energy transition, wind turbines are needed, along with adequate financial support for the providers. Currently, the federal government is promoting the expansion through auctions in which the provider with the best price-performance ratio is awarded the contract, explains Dr. Marion Ott in the #ZEWPodcast: “In these auctions, a certain capacity to be installed is put out to tender, and the producers who want to build wind turbines or solar plants submit their bids that indicate what support they want,” she says. “The bids with the lowest requested support will then be awarded the contract.” This competitive procedure is intended to ensure that the federal government achieves its expansion goals and at the same time does not overcompensate the providers. But for suppliers, participation in such tenders is often not very attractive. Studies show different reasons for this: The ZEW economist explains in the podcast that approval procedures are uncertain and lengthy, there is a lack of sites and even after the contract has been awarded, companies can still face legal proceedings. This often leads to less capacity being offered in tender rounds than advertised. As a result, there is a lack of competition, all the projects offered are awarded contracts and the expansion of renewable energies becomes more expensive. In the podcast, Ott rejects a suggested solution that has also been discussed at EU level, namely endogenous rationing. The idea is that, by only awarding a part of the bids in the tender process in case of undersubscription – for example the lowest 80 per cent –, the incentive to bid up to the maximum allowed price would be prevented. But a closer look reveals that this approach does not provide a solution to the original problem of low competition: The chances of winning the bid would be removed for relatively weak bidders, causing them to stay away from the auction. This logic would then also be transferred to the next lowest bidders, so that participation in the auction would drop even further. According to ZEW researcher Ott, this domino effect would only exacerbate the “problem of lack of competition”.
There is a lack of grid capacity
The location of renewable energy plants depends primarily on meteorological and landscape aspects, as they require wind or sun, for example. Wind farms are mostly located in the north on the coast or offshore and thus at a greater distance from industrial consumers in the south. This is not the case with electricity from fossil fuels; coal and nuclear power plants can be found all over the country. The energy transition therefore makes it necessary to quickly advance grid expansion in order to get the electricity from the north to the south: “We need to transport more electricity through the grids,” says Ott. At the moment, however, there is not enough grid capacity available. According to Ott, the result is often that electricity from renewable energy sources is available, but a lack of grid capacity prevents its use because it cannot be transported to consumers.
This problem becomes clear when taking a look at how the energy market works: On so-called day-ahead markets, the supply and demand of electricity are matched for the following day. Thus, “electricity is traded for Germany at a uniform price, regardless of where it is generated and demanded.” In recent years, however, due to a lack of grid capacity, power plants that had not been awarded the contract often had to be activated as replacements for the plants that had actually been awarded the contract. In order to mitigate the need for these redispatch measures, a bidding zone review is currently being carried out in Europe. The idea is to establish the European bidding zones in such a way that they are oriented towards the structural shortcomings in the transmission grid. Germany, which has so far been a single bidding zone, could – in view of the supply and demand gap mentioned at the beginning – be divided into a northern and a southern bidding zone, for example. A more flexible solution than introducing new smaller but static bidding zones would be to introduce a day-ahead electricity market with so-called nodal pricing, which considers the grid constraints in each trading period when matching supply and demand.