Market4RES: Opportunities, challenges and risks for renewables integration in European electricity markets

Market4RES project in a nutshell
Market4RES is a project funded by the Intelligent Energy Europe program of the European Commission. The project started in April 2014 and will finish in September 2016. It investigates the potential evolution of the Target Model (TM) for the integration of European electricity markets that will enable a sustainable, functioning and secure European power system with large amounts of renewables. More information in the project article about Market4RES.

Methodology
In order to identify the existing and future market distortions on the very short-term, short-term and long-term markets when having high shares of RES-E penetration, empirical case studies analyses were conducted by E N.V. Several countries were analysed, spanning different market regions in the European electricity market with varying RES-E penetration. These countries include:
- Central Western European (CWE) Region: Germany, France, the Netherlands, Belgium;
- Iberian Region: Spain, Portugal;
- Nordic Region: Norway, Sweden, Denmark, Finland.
The countries were selected based on the availability of data and the presence of partners of those countries in the Market4RES consortium. Historical data was gathered from January 2006 until 31 December 2014 where possible through desk research and the involvement of partners.

Major historical events happening in EU markets were analysed and indicators developed.

The relevant cases were classified into three different categories:
A. Events linked to changing environmental policy: increasing renewables uptake
B. Events linked to improving economic efficiency of markets: market coupling and interconnections
C. Events linked to security of supply: conventional supply changes

Results of the case studies

A. Events linked to changing environmental policy.
Price levels are influenced by several elements, such as the overall installed capacities compared to demand, the renewable energy share in individual country energy mix, and the capacity of interconnectors.

The analysis illustrates that with increasing shares of RES-E, average spot and futures prices tend to fall (a phenomenon that can be explained by the “merit-order effect”). For example, with close to zero variable costs, wind and solar generation can directly reduce wholesale market prices. These energy contributions can replace more expensive fossil-fuel electricity production. When a certain injection of RES-E is predicted with an almost zero marginal cost, the bid curve reverses, with renewables dispatched ahead of conventional generation effectively lowering wholesale market prices.

There also appears to be a positive correlation between price trends and RES-E share percentage, though other factors are also important in setting spot and futures prices. Results on the intraday and futures markets are similar.

Prices are influenced by supply relative to demand at specific points in time and will only decrease if capacities are too high relative to demand or if the electricity mix and flexibility of the system do not correspond to the needs of the rising renewable shares and changing consumer patterns [1].

With increased penetration of RES-E, negative prices also occur more frequently on the spot market due to the intermittency of these energy sources. Germany, for instance, experienced 297 hours of negative prices on its day-ahead market since 2008 [2], hitting a low of -500 €/MWh in 2009. Though wind overproduction is often held responsible for negative prices, three major elements can explain the occurrence of these price events [3]: the high production subsidies and the lack of appropriate market incentives to address negative market prices, the limited flexibility of conventional power plants, and the must-run conditions of conventional power plants. The occurrences of negative prices on the wholesale markets signal, as a result, the need for more flexible electricity supply and demand through adaptation of systems components and reinforce the need for better integration of renewable generation sources to the power grid [4].

Furthermore, the analysis could not conclude that there is a clear correlation between the share of RES-E penetration and the spot and futures prices on the market. However, the level of interconnection is a key driver to volatility as will be shown later.

Finally, high RES-E generation coupled with low demand can create a need for curtailing renewable capacity. “Curtailment” is an option that some system operators employ as a consequence of constraints in distribution and transmission grids to deal with overabundance of electricity production on the system. Electricity producers can also be shut down for certain periods of time to balance the grid and secure stability of the system when there is, for example, network faults. Curtailment results in economic losses, as the power that could be generated from RES-E at that time goes unused. Spain in particular makes extensive use of curtailment due to its high wind production levels, lack of interconnection to neighbouring markets (particularly France and Portugal), must-run conditions of some non-RES units, and low demand levels at off-peak times.

B. Events linked to improving economic efficiency of markets
When looking at the impact of market coupling on electricity prices, it can be observed that market coupling optimises the spot prices and flows between interconnectors since generators benefit from increased export capacity and consumers from more import capacity. Moreover, there is a noticeable convergence of average monthly and yearly futures prices after the Central-Western European (CWE) market coupling announcement. Market coupling must however be paired with sufficient interconnection capacity to realise its full effect.

Market coupling, moreover, has an impact on price volatility. More RES-E paired with high interconnection capacity tends to lead to lower and more stable prices. For example, the Nordic market has high RES-E shares, but low price variability because of its relatively high interconnection capacity, whereas Spain and Portugal have high price volatility due to high RES-E production and relatively low interconnection capacity to export excess electricity production. Volatility on the spot markets increases when interconnectivity is low. Therefore, real price volatility decreases only come with huge investments in grid infrastructure. 

For the futures market, the analysis revealed that monthly futures price volatility within and between countries in the CWE region decreases after the market coupling in September 2010.

C. Events linked to security of supply
The analysis of nuclear maintenance and phase-out events reveals that building interconnection capacity is a key to ensuring security of domestic supply and stable spot price levels during low production periods. The announcement of the shutdown of a nuclear plant temporarily drives yearly futures prices up, but other factors such as higher shares of RES-E and the possibility to import cheaper energy from neighbouring countries through interconnectors play a greater role in influencing prices in the long term.

Futures markets are highly responsive to security of supply issues. In Belgium, results of tests on the mechanical properties of the nuclear reactors Doel and Tihange indicate higher than expected risks for irradiation at the end of March 2014. As a result, outages of both plants have happened earlier than planned. In July and August 2014, the FANC (Federal Agency for nuclear control in Belgium) decided to keep both nuclear power plants temporarily offline until further assessment.

Looking at the relationship between market prices and commodity prices, one can observe that there is some correlation between the TTF Gas prices and the day-ahead market prices, at least for the Netherlands (where gas-fired power plants account for a large proportion of the electricity production facilities). However, the correlation between the European Brent oil prices and day-ahead market prices appears to be nearly non-existent. A plausible explanation for this is that oil is not usually considered a direct substitute for electricity and there is little oil used in the current production of electricity. Monthly futures natural gas prices are mostly positively correlated with the monthly futures power prices.

Measures for optimal market design

Increasing renewable shares, market coupling and conventional supply changes are not unique European trends. Other jurisdictions around the world are confronting similar challenges, but may be addressing them in different ways. Therefore, the Market4RES project looked beyond European borders by highlighting developments and best practices implemented in international markets with similar energy challenges to Europe. Solutions and measures that are relevant to the European context are briefly described hereunder (non-exhaustive list), with the view to inform market design policies in Europe to better optimise RES-E integration on the electricity system.

Increase interconnection capacity. Building new interconnections to control price volatility, increase market efficiency and flexibility is the key to managing intermittent renewable sources. This measure equally applies when there is an over production of generation and when there is security of supply issues, for example, when nuclear plants go offline for maintenance or permanent shutdown.
Support demand management. Demand-side response (DSR) should be incentivized in order to better match supply with demand. DSR can shift consumer demand to off-peak periods during periods of high demand and incentivise consumption during high production and/or traditionally low demand periods. Technical infrastructure, such as smart meters, may be required to enable flexible demand.
Increase flexibility operations. There are several ways to increase flexibility of the system through flexible operation measures, for example, merging balancing areas, sharing flexible generation assets, sharing back-up reserves, etc. Having stand-by capacity that can ramp up rapidly can also provide more flexibility to the system.
Improve forecasting techniques. More sophisticated and accurate forecast of RES-E availability can reduce the need for back-up capacity. Another part of the solution is to decrease the lead-time for forecasts through intraday markets which would improve forecast accuracy.
Optimise interplay of intraday, balancing and day-ahead markets. Intraday and balancing markets should be designed to make full use of the flexibility of the transmission system and the different generation technologies. For instance, lead time available to pursue system adjustments could be increased, gate closure delays reduced and it should be possible to reschedule power flows between countries more often.

References

[1] Batlle, C., Banez-chicharro, F., Frías, F. P., Linares, P., Olmos, L., Rivier, M.,  Eeg, T. U. W. (2013). Design and impact of a harmonised policy for renewable electricity in Europe Derivation of prerequisites and trade-offs between electricity markets and RES policy framework 2020.
[2] EPEXSPOT
[3] KU Leuven Energy Institute. (2014). Negative electricity market prices, 1–5. Retrieved from http://set.kuleuven.be/ei/images/negative-electricity-market-prices
[4] European Commission (2014). Quarterly Report on European Electricity Markets. DG Energy Market Observatory for Energy, 7.