An Electricity Market Design Fit for Cleantech Competitiveness

The transition to a new energy system is set to bring a shock to our ageing grid infrastructure: production is becoming increasingly decentralized, new loads like electric vehicles and heat pumps are coming online, and consumers are becoming producers as well. The grid of the future needs to be able to absorb this shock, not only with infrastructure upgrades but with the adoption of digital technologies to increase overall system flexibility.

Today, wind and solar are the cheapest forms of new electricity generation that is added to the European electric grid. However, due to its intermittent nature, excess renewable power gets curtailed (i.e., wasted), due to the inability of the energy system to absorb excess production. At the same time, when renewable generation falls short of power demand, we rely on expensive imported natural gas to run “peaker” plants. The current electricity market forces a reliance on imported natural gas for system flexibility, jeopardizing Europe’s climate commitments and energy resilience. It also significantly harms economic competitiveness, by failing to provide access to long-term, affordable and clean electricity procurement for cleantech industries like battery production and green steelmaking.

The Electricity Market Design (EMD) reform is an indispensable opportunity to accelerate the wide deployment of clean technologies and achieve REPowerEU objectives. It is also a critical opportunity to supply abundant, cheap and clean electricity to rising cleantech industries.

The EU must redesign its electricity market for speed, scale, and simplicity. A timid EMD reform which does not turbocharge Europe’s electricity system decarbonization would be a lost opportunity, as a broad array of clean technologies that can help are now ready to be deployed.

EU-based innovators are ready to scale multiple hardware and software solutions to solve this challenge, including long-duration energy storage, demand-response, aggregation of distributed assets (e.g., EV-batteries), vehicle-to-grid, peer-to-peer and community energy trading, grid topology optimisation, near-term renewable generation forecasting (nowcasting), load forecasting, automated grid management, modelling and optimisation, superconductors, innovative cables, sensors and converters, substations, advanced metering and data logging. It is vital that the future electricity market catalyses the mobilization of these technologies to support renewables, grid flexibility, and ageing grid infrastructure.

EMD reform is an opportunity to rejig our power system to prioritize and deploy grid innovation: from energy production, to storage, transmission and distribution, while creating the conditions for increased cleantech manufacturing in Europe. Following consultations with some of the EU’s prominent cleantech innovators and investors, we make three concrete proposals to build an electricity market design fit for cleantech competitiveness.

Proposal 1: Create a system fit for abundant, cheap and clean electricity

Increased clean electricity production is a prerequisite to cheaper electricity and increased grid flexibility. The consultation calls renewables “Europe’s way out of the crisis” and rightly argues that the reform must “preserve and enhance the incentives for investments and provide investors with certainty and predictability”. Power Purchase Agreements (PPAs) and Contracts for Difference (CfDs) have the potential to incentivize much higher grid penetration of innovative renewables such as advanced geothermal, floating offshore wind, and ocean energy, by allowing stakeholders to set competitive pricing schemes that enhance competitiveness while hedging against long-term risks.

PPAs help consumers get cost-competitive electricity and hedge against price volatility, while giving producers long-term stability and visibility over their future revenues. However, to date, PPAs remain limited to a few Member States, utilities, and large corporates (notably US Tech Giants). PPAs should become much more accessible to smaller energy consumers through demand pooling, auctions, and guarantee schemes. Much longer PPA contract durations of, say, 10-15 years, should be made possible too (for example, 35-year contracts are possible in Iceland).
This matters for critical cleantech industries of the next decades. For instance, electricity prices can account for a significant share of production costs for European battery gigafactory developers. This harms their competitiveness, as competitors in China and the US can sign long-term "cost-plus” contracts at lower rates, giving them cost stability driving investor confidence. Innovative European cleantech manufacturers require easily accessible, liquid PPA markets to compete. Additionally, establishing a definition of 24/7 clean PPAs with verifiable guarantees of origin would incentivize suppliers of PPAs to develop more geographically and technologically diversified portfolios comprising innovative renewables and grid flexibility solutions.

A greater reliance on CfDs would incentivize the deployment of innovative renewables while enabling the softening of future price spikes. In particular, CfDs should be voluntary, and linked to the demand side and uptake of innovative clean technologies.

Proposal 2: Enable business models for a more flexible electricity system

Clean grid flexibility consists primarily of long-duration energy storage (LDES) and demand side response. Energy storage and demand response improve the alignment of variable renewable energy (VRE) supply and demand: energy storage shifts the timing of supply while demand response shifts the timing of demand. Both can significantly increase the penetration of VRE while also providing firm capacity, which eliminates the need for gas-fired peaking capacity.

The latest European electricity market revision in 2019 improved system flexibility by introducing provisions entitling consumers who have a smart meter to access dynamic pricing, and by introducing rules on demand response, including aggregation, energy storage and demand curtailment. European DSOs are experimenting with new models of pricing which can shift consumption patterns. Now is the time to deploy them at scale in a connected way to support a full rollout of the technologies on which our future energy system depends.
However, the 2019 revision was designed for a 32% RES by 2030 target, not today’s 45% target set by REPowerEU. Moreover, the revision has not been fully implemented by Member States, and now, some are using the coming reform to further delay implementation. Hence, Commission proposals to improve data granularity through submeters and new products to shift or reduce demand are welcome developments, but implementing existing rules is equally important.

There is tremendous innovation in this space, but innovators need easy rules to access these markets and openness of incumbent operators to utilize them. For example, smart regulation has enabled the development of curtailment reduction business models: Transmission lines face thermal constraints which resulting in curtailment. DSO congestion management platforms such as GOPACS in the Netherlands or Piclo Flex in the UK should be launched across the EU, whereby these flexibility providers bid for flexibility contracts from system operators. Additionally, support the introduction of faster response products, such as dynamic containment (UK), fast frequency response (Ireland), and fast reserve (Italy). Finally, let willing Member States extend the current TSO curtailment cap of 5% to renewables penetration rates of more than 50%.

Currently, gas “peaker” plants win the majority of capacity auctions because capacity mechanisms are limited to an unambitious emissions cap of 550g of CO2 per kWh. To level the playing field for clean technologies, the emissions cap should be set at 250g of CO2 per kWh – as the European Investment Bank has done for its energy investments – and gradually lower the cap to zero. Additionally, providers of clean capacity should be eligible for higher capacity payments and longer contracts based on carbon content/being below a certain CO2 threshold. Alternatively, capacity mechanisms could include a premium for curtailment reduction. The US is ahead of Europe in remunerating clean capacity providers, giving US innovators a leg up over European ones in scaling their technologies.
Additionally, resource adequacy reports should account for how much renewable energy is curtailed annually, to reduce (wasteful) curtailment of clean power through greater deployment of cross-border interconnections (at least 15% by 2030), demand response, and energy storage. Permitting will also have to be upgraded for the grid of the future. Time to grid connection must be shortened and dedicated permitting procedures should be put in place for renewables and LDES colocation and standalone storage solutions.

Allowing energy storage assets to be technically classified as transmission and distribution (T&D) assets would further encourage the deployment of energy storage for system balancing, instead of deploying more expensive transmission lines. Likewise, innovative digital technologies that enhance existing T&D efficiency (e.g., superconductors) should be promoted through efficiency incentives that would also defer the need for new (lengthy) grid infrastructure build-out.

Finally, cross-border trading enables national grids to be leaner, increases energy security, and drives renewables deployment. Yet it is underpinned by highly volatile spot markets. Hence, better functioning forward markets would enable electricity generators and consumers to hedge against spot market volatility. The streamlining and harmonization of market rules and digital standards would unlock greater cross-border trading and real-time data sharing.

Proposal 3: Build the required infrastructure to succeed

While grid flexibility solutions allow us to make the most out of existing grid infrastructure, we will need more and better infrastructure – such as high voltage transmission lines, cross-border interconnectors, and energy islands – to accommodate increasing electrification and power demand.

While global investment growth in renewables needs to be three times faster to reach net zero by 2050, the rate of grow in electricity grids needs to be more than six times faster. Additionally, transmission lines and other distribution infrastructure can take significantly longer to plan, permit, and build than solar and wind projects. Decisive action is required for Europe to overcome this dual challenge of speed and scale.

It is encouraging that the Commission is fast-tracking permitting in so-called “go-to areas”, but transmission permitting deserves unique attention; Europe has not made significant transmission investments since the 1990s, leading to congestion management costs. However, in places where community resistance or excessively slow and cumbersome permitting will continue to hinder new construction, transmission capacity can be expanded by replacing steel-reinforced lines with composite-core lines or HVDC lines, and making use of high-temperature superconductors and innovative line-monitoring technology. Ultimately, however, these technologies are not a replacement for genuine systemic changes and the construction of new grid infrastructure from generation to consumption and everything in between.

Financing this infrastructure build-up should not come at the cost of higher energy prices for consumers and cleantech manufacturing industries. The current openness to review State Aid rules may provide an opportunity to finance such needed infrastructure that way, turning it into a critical investment project of the next decades.

Interviewed for this paper:

  • René Savelsberg and Till Stenzel, SET Ventures, Netherlands-based venture capital firm specializing in the energy systems transition
  • Caroline Mini and Olivier Dufour, Verkor, France-based battery gigafactory developer producing low-carbon batteries for electric vehicles and stationary storage
  • Ola Hansén and Jesper Gyberg Ek, H2 Green Steel, Sweden-based developer of a large-scale near zero-carbon steel plant
  • Ben Potter and Federico Minoli, Energy Dome, Italy-based CO2 Battery developer for long-duration energy storage
  • Mathilde Chareyron, Sympower, Netherlands-based provider of advanced flexibility solutions for an intelligent and emissions-free energy system

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