Innovating electricity market design to achieve an efficient decarbonisation process

In this paper, Hannelore Rocchio (ENI – Regulatory Affairs and Strategy Support, Executive Vice President) and Federico Boschi (Independent Energy Economist, former ARERA Director of the Gas and Power market Department) explore an innovative approach to the evolution of electricity market design and suggest the introduction of three distinct forward markets to ensure an efficient decarbonization process: the ‘Pro-Security Forward Market’; the ‘Pro-Decarbonisation Forward Market’ and the ‘Pro-Adequacy Forward Market’.

The electricity market was designed to pursue multiple objectives, including those of efficiency through the promotion of competition. These traditional objectives have been complemented by an additional one, decarbonization, which in recent years has taken a predominant role, with relevant implications for the electricity market design: it requires a progressive and significant increase in the share of electricity produced from renewable sources and introduces a series of problems in terms of adequacy and security of the system, so far neglected in the design of the wholesale power market. The current market design is almost exclusively focused on spot markets (energy and ancillary services), assuming that the price signals provided by the spot market are on their own ability to ensure the availability (in real-time) of an adequate mix of resources.

This approach – which has already started to show its shortcomings – seems hardly compatible with the pursuit of decarbonization goals. In fact, the development of renewables emphasizes the problem of the ability of wholesale markets to provide, through spot prices only, an effective incentive to stimulate an adequate level of investment in new generation capacity “at the right time, in the right places, and using the right technologies”. This failure becomes particularly critical today to the extent that the progressive increase in the penetration of production from RES, also due to their not fully-dispatchable characteristics, creates the need to integrate additional resources into the generation portfolio.

We, therefore, envisage the introduction of a “hybrid” market structure in which there is a short-term energy market  – that focus on operating the existing stock of generation capacity efficiently and setting efficient day-ahead and day-of (real-time) energy and ancillary services prices – and a long-term procurement forward markets.  More precisely, we suggest the introduction of three distinct forward markets, placed in sequence over time in order to ensure efficient coordination: the “Pro-Security Forward Market”; the “Pro-Decarbonization Forward Market” and the “Pro-Adequacy Forward Market”.

This should be done in order to:

• ensure the availability of a minimum quantity of resources with the aim of maintaining system security and adequacy whilst achieving the decarbonization objectives.
• create an “environment” that, leveraging on available assets, is capable of promoting merchant initiatives for the development of renewables and storage, for example via PPA; in other words, centralized forward contracts should not eliminate the space for merchant initiatives, but limit themselves to what is strictly necessary to encourage their development;
• achieve efficient coordination between the various forward contracting mechanisms and market initiatives, to maximize synergies and allow correct exploitation of the externalities that each of these produces on the others;
• ensure full compatibility with the functioning of the spot markets, so that they can express correct signals on the actual value of resources in order to maximize short-term (productive and allocative) efficiency.

Read the paper here!