Periodic Reporting for period 4 - ELECTRIC CHALLENGES (Current Tools and Policy Challenges in Electricity Markets)
Okres sprawozdawczy: 2023-03-01 do 2024-08-31
Around the world, governments are increasingly committed to fighting climate change through ambitious environmental policies. Notably, the European Union aims to reduce emissions by 55% in 2030 and become carbon neutral by 2050, with initiatives such as the European Green Deal and the Fit-for-55 package designed to achieve these goals more effectively. The ERC Project ELECTRIC CHALLENGES focuses on the power sector, exploring key issues related to market design and policy within this context. By employing rigorous theoretical, empirical, and simulation tools, the project has advanced the research frontier in this area while contributing to policy discussions aimed at ensuring an energy transition that minimizes societal costs.
First, we have examined the strength of pricing incentives in encouraging a more active role for electricity consumers. This is crucial for the deployment of renewable energy, which is highly dependent on changing weather conditions. Consumers' responsiveness to price changes can facilitate the transfer of demand from periods of low to high renewable availability, resulting in more efficient use of renewable resources, reduced carbon emissions, and a decreased reliance on conventional backup capacity. These issues have become even more relevant in light of the energy crisis in Europe from 2021 to 2023.
Second, while the goal is for power markets to become carbon-free within two decades, it remains uncertain how these markets will perform. Understanding whether final consumers will benefit from the energy transition and whether electricity markets provide sufficient incentives for firms to invest in renewables and energy storage is critical. Our project has provided valuable insights into these concerns.
Third, beyond current market arrangements, we have sought to identify the most effective policies to promote investment in renewable energy and storage. Understanding firms' strategic behavior is essential for determining whether the market structure and firms’ technological portfolio will influence the effectiveness of such policies. Similarly, it is important to understand the socio-economic impacts of renewable energy in the municipalities that host these investments. Evidence of weak or even negative effects on host communities could challenge environmental justice and become a bottleneck for further deployment.
First, we have examined the strength of pricing incentives in encouraging a more active role for electricity consumers. This is crucial for the deployment of renewable energy, which is highly dependent on changing weather conditions. Consumers' responsiveness to price changes can facilitate the transfer of demand from periods of low to high renewable availability, resulting in more efficient use of renewable resources, reduced carbon emissions, and a decreased reliance on conventional backup capacity. These issues have become even more relevant in light of the energy crisis in Europe from 2021 to 2023.
Second, while the goal is for power markets to become carbon-free within two decades, it remains uncertain how these markets will perform. Understanding whether final consumers will benefit from the energy transition and whether electricity markets provide sufficient incentives for firms to invest in renewables and energy storage is critical. Our project has provided valuable insights into these concerns.
Third, beyond current market arrangements, we have sought to identify the most effective policies to promote investment in renewable energy and storage. Understanding firms' strategic behavior is essential for determining whether the market structure and firms’ technological portfolio will influence the effectiveness of such policies. Similarly, it is important to understand the socio-economic impacts of renewable energy in the municipalities that host these investments. Evidence of weak or even negative effects on host communities could challenge environmental justice and become a bottleneck for further deployment.
The project has produced 20 publications, which we group and discuss in five blocks:
I. Papers on renewable energies:
Our work highlights the paradigm shift in electricity markets brought about by the deployment of renewable energies. There are two key competitive differences between conventional and renewable technologies. First, the marginal cost of conventional power plants depends on their efficiency and the price at which they purchase fossil fuels. In contrast, the marginal cost of renewable generation is essentially zero. Second, the capacity of conventional power plants is well-known, as they tend to be available at all times. Conversely, the availability of renewable plants is uncertain and intermittent. Thus, the transition from fossil-fuel generation to renewable sources implies a shift in the competitive paradigm, where marginal costs are predictable (and nearly zero), but firms' available capacities become private information.
We have developed a model of competition in renewables-dominated electricity wholesale markets that reflects this new paradigm. Our paper demonstrates that renewables mitigate market power compared to conventional resources, although price volatility and positive markups will persist until the full renewable rollout is completed. We also show that firms' technological portfolios will be critical in determining whether this transition is prolonged, with specialized structures making it more difficult to alleviate market power concerns.
Policy design is critical in this shift. We analyzed regulatory changes in Spain (2013-2014), finding that fixed-price payments for renewables, rather than market-based premiums, effectively reduced market power and improved consumer surplus. Additionally, we assessed auction designs for renewable capacity, comparing technology-neutral and technology-specific approaches, as well as quantity-based (auctions) and price-based (tariffs) instruments. Our results show these choices directly affect technology selection and the cost of investments for consumers.
Local socio-economic impacts are also important in understanding renewables' benefits. We studied the labor market effects of solar and wind rollouts in Spain, finding significant differences: solar projects generally generate stronger, though modest, local employment impacts than wind, with variations based on project size.
II. Papers on electricity pricing policies and demand response:
Since 2015, all Spanish households have, by default, paid tariffs that reflect hourly changes in the wholesale cost of electricity production. This makes Spain a unique case for testing whether pricing incentives are sufficient to trigger a more active demand response. We gathered a large dataset of Spanish households' hourly electricity consumption, which enabled us to estimate the price elasticity of demand. Our findings were robust: on average, households exhibit a price elasticity of zero. Several potential explanations could account for this: a lack of consumer awareness, costly information acquisition, and minimal demand response due to low price variation.
Dynamic pricing also raises equity concerns. Our data show that real-time pricing slightly increased bills for low-income households (average 0.5% rise), with the most affected experiencing a 5% increase. Although this effect was modest overall, higher volatility due to expanded renewables could lead to more significant impacts. We also contributed a new method for inferring individual-level income in data-rich but income-scarce environments, enhancing equity analysis in energy studies.
III. Papers on energy storage:
Evidence of the limited effects of dynamic pricing prompted us to explore the impact of another major policy aimed at supporting the renewable energy transition: the use of storage facilities. This line of research combines both theoretical modeling and simulation analyses to assess the incentives for investing in and operating storage facilities. Our findings indicate that market power can distort the efficient use of these facilities, reducing the incentives to invest. We also show that renewable energy and storage can either complement or substitute each other, depending on demand seasonality and the availability patterns of the renewable technology, with market power amplifying these dynamics.
IV. Papers on energy policies, the energy crisis, and the COVID pandemic:
Two major unexpected events occurred during the project’s duration: the COVID-19 pandemic and the energy crisis. These events prompted us to analyze their implications through an energy-focused perspective. Notably, our research sheds light on how to effectively reform European electricity markets to mitigate the worst consequences of the crisis while advancing the green agenda.
V. Publications by team members (not included in the DoA):
Team members also produced 5 publications on topics related to climate and energy policy.
I. Papers on renewable energies:
Our work highlights the paradigm shift in electricity markets brought about by the deployment of renewable energies. There are two key competitive differences between conventional and renewable technologies. First, the marginal cost of conventional power plants depends on their efficiency and the price at which they purchase fossil fuels. In contrast, the marginal cost of renewable generation is essentially zero. Second, the capacity of conventional power plants is well-known, as they tend to be available at all times. Conversely, the availability of renewable plants is uncertain and intermittent. Thus, the transition from fossil-fuel generation to renewable sources implies a shift in the competitive paradigm, where marginal costs are predictable (and nearly zero), but firms' available capacities become private information.
We have developed a model of competition in renewables-dominated electricity wholesale markets that reflects this new paradigm. Our paper demonstrates that renewables mitigate market power compared to conventional resources, although price volatility and positive markups will persist until the full renewable rollout is completed. We also show that firms' technological portfolios will be critical in determining whether this transition is prolonged, with specialized structures making it more difficult to alleviate market power concerns.
Policy design is critical in this shift. We analyzed regulatory changes in Spain (2013-2014), finding that fixed-price payments for renewables, rather than market-based premiums, effectively reduced market power and improved consumer surplus. Additionally, we assessed auction designs for renewable capacity, comparing technology-neutral and technology-specific approaches, as well as quantity-based (auctions) and price-based (tariffs) instruments. Our results show these choices directly affect technology selection and the cost of investments for consumers.
Local socio-economic impacts are also important in understanding renewables' benefits. We studied the labor market effects of solar and wind rollouts in Spain, finding significant differences: solar projects generally generate stronger, though modest, local employment impacts than wind, with variations based on project size.
II. Papers on electricity pricing policies and demand response:
Since 2015, all Spanish households have, by default, paid tariffs that reflect hourly changes in the wholesale cost of electricity production. This makes Spain a unique case for testing whether pricing incentives are sufficient to trigger a more active demand response. We gathered a large dataset of Spanish households' hourly electricity consumption, which enabled us to estimate the price elasticity of demand. Our findings were robust: on average, households exhibit a price elasticity of zero. Several potential explanations could account for this: a lack of consumer awareness, costly information acquisition, and minimal demand response due to low price variation.
Dynamic pricing also raises equity concerns. Our data show that real-time pricing slightly increased bills for low-income households (average 0.5% rise), with the most affected experiencing a 5% increase. Although this effect was modest overall, higher volatility due to expanded renewables could lead to more significant impacts. We also contributed a new method for inferring individual-level income in data-rich but income-scarce environments, enhancing equity analysis in energy studies.
III. Papers on energy storage:
Evidence of the limited effects of dynamic pricing prompted us to explore the impact of another major policy aimed at supporting the renewable energy transition: the use of storage facilities. This line of research combines both theoretical modeling and simulation analyses to assess the incentives for investing in and operating storage facilities. Our findings indicate that market power can distort the efficient use of these facilities, reducing the incentives to invest. We also show that renewable energy and storage can either complement or substitute each other, depending on demand seasonality and the availability patterns of the renewable technology, with market power amplifying these dynamics.
IV. Papers on energy policies, the energy crisis, and the COVID pandemic:
Two major unexpected events occurred during the project’s duration: the COVID-19 pandemic and the energy crisis. These events prompted us to analyze their implications through an energy-focused perspective. Notably, our research sheds light on how to effectively reform European electricity markets to mitigate the worst consequences of the crisis while advancing the green agenda.
V. Publications by team members (not included in the DoA):
Team members also produced 5 publications on topics related to climate and energy policy.
This is the final report. Hence, all the results and progress have been described above.