According to the International Energy Agency (IEA), the way in which we generate, purchase and distribute electricity needs to change if we are to win the fight against climate change. In a major report published in February 2016, the IEA outlines the key policies that should be adopted on a global scale to ensure that the global electricity market is equipped to power a low-carbon world.

What is clear is that, whilst electricity generation technology has revolutionised in recent years, advances in the regulatory regime and market design of most electricity markets have noticeably fallen behind.

“For a century, a centralized high-carbon power system kept the lights on,” stated IEA Executive Director Fatih Birol in the report. “If regulatory regimes, market design and system operation end up lagging behind technology deployment, the result may undermine electricity security and, ultimately, the low-carbon transition itself.”

Most countries’ renewable energy focus lies predominantly with wind and solar – intermittent sources of energy which, according to Birol, will require a wholesale redesign of energy markets to implement at scale.

“Rapid improvements in low-carbon, demand-response and storage technologies can lead to a smarter, more efficient and more secure system, but achieving their full potential requires new approaches to policy and regulation,” he said in the report.

The key is designing and implementing an electricity market which encourages low-carbon investments while maintaining security of supply. The IEA suggest that changes to network investments, regulations, capacity markets, and integration processes are all required, although at no point is there an indication of what would make the “perfect market design” in a low-carbon world.

We face a serious challenge: the average CO2 intensity of electricity needs to fall from 411g per kWh in 2015 to 15g per kWh by 2050 for us to achieve our goal of limiting the global increase in temperatures to 2 degrees Celsius.

However, the IEA have put forward five key recommendations that could pave the way for a more suitable and appropriate low carbon energy market:

1. Continuation of long-term support

The issue we face is that the 2030 decarbonisation objectives require the deployment of low-carbon technologies at a faster pace than the planned timescales for retirement of older and dirtier generation stock. The IEA claims that because market forces on their own will not be enough to drive this transition, long-term measures to promote investment in low-carbon power generation are vital to attain decarbonisation of the power system before levels of global warming reach dangerous heights.

One recommendation from the IEA is for government-backed support structures to be designed so that risks are shared between investors, consumers and governments. For example, in the UK, the Contracts for Difference (CfD) scheme has created an energy market auction process in which certain low carbon technology generators can obtain public financial support to enable them to compete at lower price points, which in turn benefits consumers. It also suggests that energy market auctions work well in generating competitive low-carbon technologies while allowing for greater control over the capacity deployed.

2. Modernised tariffs

Through the growth of new technologies such as battery storage and decentralised generation, the consumer energy market is starting to see much greater price elasticity. The IEA suggests that it is key for electricity market systems to be more fluid in line with price fluctuations; allowing smaller electricity players to respond more easily to movements in the wholesale electricity price.

Additionally, it is suggested that retailers should aim to inform customers more regularly and accurately of any adjustments in the price for energy. This would allow such retailers to alter their behaviour appropriately and send accurate market signals back up the chain to encourage efficient investment choices.

3. Temporal and geographic pricing

As the level of renewable energy in the electricity system grows, it will be important to strengthen short term markets and develop flexible price signals to ensure energy security. The IEA recommends a market design with a high “temporal and geographical resolution”, i.e. one that allows prices throughout a country to fluctuate based on location and weather patterns. However, further research is needed to determine the kind of pricing structures that would work best in national markets.

4. Carbon costs

The report notes that “electricity prices in most countries today are too low to recoup the investment costs of any low-carbon technology, including renewables and nuclear”. Therefore, to promote investment in low-carbon generation, markets need a “high and robust” carbon price.

5. Overhaul networks

According to the IEA, a key factor holding back true progress in the wind and solar energy sectors is the inadequate transmission networks in many countries. To stimulate development of these sectors, governments need to explore cross-border transmission lines and introduce transmission auctions to generate innovation and competition.

Similarly, an overhaul of distribution network regulations would allow for the introduction of new “distributed energy sources” such as heat pumps, micro turbines, solar arrays, energy storage and demand-response systems.

BLP Key Takeaways

Whilst we all understand the importance of renewable energy generation, the IEA report shows that the design of the energy market in which such generation is regulated, transmitted and distributed is just as vital. But what does this mean for those active in the renewable energy space both in the UK and abroad?

Firstly, policymakers and regulators must come to terms with the fact that our electricity market will look very different to that which delivered the carbon-intensive, centralised, and environmentally unsustainable energy on which we currently rely. In order to have the flexible and sustainable low carbon market that we all want, a push for continued and appropriate long-term support mechanisms is vital.

Secondly, questions need to be raised as to whether the design of our current electricity market is sufficient to cope with an increase of intermittent low carbon energy sources. Better geographic and temporal pricing as well as developments to our distribution networks and transmission systems, especially cross-border, can only help to create a more flexible and efficient international energy system.

Lastly, what new technologies can we be implementing that can assist in creating an improved market design? One key area is Smart Energy. The idea here is that through energy storage systems, we save energy at times of low demand (where customers can then rebates on their energy bills) and use that stored energy at times of high demand. This is a “smart” way of getting round the pitfall of intermittent low-carbon generation and rewarding not just generators for producing green energy but customers for saving it.