The European power system will be based on wind power, solar PV and flexibility.
The existing climate targets for 2030 imply a renewables share of some 50 percent in the electricity mix, with wind and PV contributing some 30 percent. The reason is simple: they are by far the cheapest zero-carbon power technologies. Thus, continuous investments in these technologies are required for a cost-efficient transition; so are continuous efforts to make the power system more flexible at the supply and demand side.
Making the Energy-Only Market more flexible and repairing the EU Emissions Trading Scheme are prerequisites for a successful power market design.
A more flexible energy-only market and a stable carbon price will however not be enough to manage the required transition to a power system with high shares of wind and solar PV. Additional instruments are needed.
A pragmatic market design approach consists of five elements: Energy-only market, emissions trading, smart retirement measures, stable revenues for renewables, and measures to safeguard system adequacy.
Together, they form the Power Market Pentagon; all of them are required for a functioning market design. Their interplay ensures that despite legacy investments in high-carbon an inflexible technologies, fundamental uncertainties about market dynamics, and CO2 prices well below the social cost of carbon, the transition to a reliable, decarbonised power system occurs cost-efficiently.
The Power Market Pentagon is a holistic approach to the power system transformation. When designing the different elements, policy makers need to consider repercussions with the other dimensions of the power system.
For example, introducing capacity remunerations without actively retiring high-carbon, inflexible power plants will restrain meeting CO2 reduction targets. Or, reforming the ETS could trigger a fuel switch from coal to gas, but cannot replace the need for revenue stabilisation for renewables.
As consequence of Europe’s climate and energy agenda, the European Union will generate some 50 percent of its electricity from renewables by 2030. By 2050, the EU’s power system will have to be completely carbon-free. Solar photovoltaics and wind power – driven by significant cost reductions – will almost certainly contribute the biggest share of the zero-carbon technologies. Given the specific characteristics of wind power and photovoltaics (intermittent generation, high capital costs, very low variable costs), they will fundamentally change both market operations and the market design framework.
Decarbonisation rests on continuous investments in these technologies. Usually it is expected that the energy market will deliver these investments, in combination with the emissions trading system. But is this view, based on simple textbook economics, enough to enable the required investments under real world conditions? In this paper, we argue that this rather theoretical view to power market design is not the way forward. Instead, a more pragmatic approach is needed, that takes into account the complex practical, political, and economic challenges of the transition towards a carbon-free power system. Thus, we propose to think of the future European market design as a Power Market Pentagon.
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The Power Market Pentagon
A Pragmatic Power Market Design for Europe’s Energy Transition