A larger market can react more efficiently to supply variations that may arise from the increased use of a variable energy source such as wind. A properly functioning single market can also provide greater opportunities for a carbon-free energy source with low marginal costs like wind to be assimilated into the market and not wasted.
Significant progress has already been made on integrating day-ahead — or spot — markets. A feature of day-ahead trading in most of northern Europe is market coupling — the sale of energy along with cross-border interconnection transmission capacity — and full price coupling should be implemented in north-west Europe later this year. It is feasible to aim for an expansion of day-ahead market coupling to the rest of Europe by 2014, which is the deadline set for the establishment of a single European energy market.
Day-ahead integration is a step in the right direction but not enough for a market looking to increase wind penetration significantly in the decades ahead. European Wind Energy Association (EWEA) figures indicate that the installed capacity across Europe at end-2011 of roughly 94GW should cover some 6.3% of electricity needs in a normal wind year. But the aim is to generate as much as 20% of European electricity from wind energy by 2020 and 33% by 2030.
With research and grid infrastructure investments, EWEA believes wind could potentially account for
half of European electricity generation by 2050.
The increase in wind generation makes it even more important to integrate intra-day and balancing markets," says Martin Crouch, chairman of the sustainable development task force of the Council of European Energy Regulators (CEER). "The closer you are to real time, the more predictable wind generation becomes, the lower your balancing needs and the lower the system costs," he says.
Major operational cost savings are possible with the greater integration of these markets that allow price movement within the day and those that allow power traders to bid to buy or sell when the market needs to be balanced, as the generation of the power fleet can be optimised across countries, says Paul Wilczek, EWEA's senior adviser on infrastructure and the internal market. Despite clear advantages, the debate about how to make the trading of power reserves technically feasible on a cross-border basis has only just begun. Progress on the intra-day front is also slow. "The will is there but we are lagging," says Wilczek.
Even the best-devised market structure cannot work without a transmission and distribution system that moves energy efficiently from point A to point B. If the physical infrastructure is lacking, cross-border markets will be illiquid and transmission bottlenecks frequent. Expanding and upgrading the European grid is widely seen as necessary for a shift to a power system with a major penetration of renewable energy — even if market participants differ on how this should be done.
Yet grid upgrade and expansion projects can be difficult to push through the permitting process. And there is no obvious way to avoid congestion problems completely, says Karsten Neuhoff, research director of climate policy impact and industry response at DIW Berlin, the German Institute for Economic Research.
"It is not economically, environmentally or politically viable to expand networks to such an extent that transmission constraints never occur," he says. "What is important is to efficiently expand the grid while simultaneously implementing effective congestion management."
One way to do that across Europe, Neuhoff suggests, could be through the application of nodal pricing, which factors transmission constraints into the price of electricity through a transparent, market-based mechanism. In a nodal pricing system, the price of energy may vary in different regions of a country to account for capacity transmission constraints. A recent analysis by Climate Policy Initiative and European partners found that introducing a congestion management system of this type could lead to annual savings of roughly €2 billion and increase international energy transfers by up to 30%.
"In the day-ahead market and with market coupling, you can see a similar approach in that countries have lower prices if they are exporting energy and there are constraints, and higher prices if they are importing," says Neuhoff. "Within Europe, this integration of energy markets and transmission allocation can be seen between several countries, although it typically has not been applied to congestion management within countries or to intra-day trading."
Operators need unity
Neuhoff notes that a European power market characterised by both increased nodal pricing and intra-day trading would require much closer co-operation between transmission system operators (TSOs) and power platforms. A cue could be taken from liberalised energy markets in the US, where a nodal pricing system has successfully been applied to day-ahead and shorter-term trading. Independent system operators (ISOs) play a fundamental role in these markets, stopping short of full-scale integration with other ISOs but agreeing on a pricing formula to ease trading across regions covered by different operators.
While TSOs in Europe have shown a willingness to collaborate, Brussels is not relying solely on voluntary efforts to progress energy-market integration. The EU's third energy liberalisation package, first enacted in 2009 but only fully implemented in March 2011, takes a more top-down approach. The European Network of Transmission System Operators for Electricity (ENTSO-E) is working on network codes for cross-border integration that involve not only aspects of the grid's functioning but delve into details of how markets should be operated on a day-ahead, intra-day and balancing-market basis.
While policy discussions have focused on how to meet the market's supply requirements, demand management is seen as having a critical future role. "There are some pretty ambitious [renewable electricity] targets out there in the longer term," notes William Webster, head of European power market design at RWE Supply and Trading, "but you're never going to get there without being much more active on the demand side."
CEER's Crouch agrees that demand-side responses need to be more flexible. "The situation we have now mainly involves large industrial customers agreeing upfront with transmission companies that in certain situations they'll reduce their demand, but there are all sorts of ideas about how to get demand to correspond to when the supply is available," he says.
Improvements in power-price-formation transparency and more liquid markets are both necessary to provide market players with the knowledge and ability to take opportunities to intervene on the demand side, believes EWEA's Wilczek.
A market with high wind-energy penetration also requires significant conventional power capacity with the flexibility to adjust production at short notice. Yet some industry players believe the market signals do not encourage investment in this backup capacity.
Almudena Huerta, a policy officer at the markets unit of industry association Eurelectric, says combined-cycle gas turbine (CCGT) plants in markets with a significant share of wind generation have seen a drop in operating hours. In Spain, for example, a typical CCGT plant was dispatched for 5,000 hours in 2004 and only 2,600 hours in 2010. "This result severely affects the business case for CCGT plants and future investment plans," she says.
Even with low operating hours, there could still be a business case for CCGTs. Huerta and others propose that in moments of supply scarcity, when CCGTs are often providing power, the prices for electricity should rise significantly. In Spain, however, a price cap limits such increases. Elsewhere, fears that price rises would not be politically feasible has stopped power producers from raising prices to the levels dictated by the market.
Market failure has led to discussion in some countries about introducing capacity remuneration payments, which would see conventional generators paid for simply having reserve capabilities available. This payment would be in addition to revenues from the sale of power on wholesale markets. "These are quick fixes — which in the end will become too expensive," says Webster. "We believe the solution is an energy price that is really reflective of supply and demand."
According to EWEA, a better assessment is needed of whether there really is a shortage of flexible backup capacity. The association thinks a more integrated market would resolve any potential profitability problems that these generators face by giving them a larger market in which to sell.
Level playing field
To integrate large amounts of wind energy, Eurelectric, CEER and the European Federation of Energy Traders all agree that wind must increasingly be exposed to market forces. At issue are support mechanisms, priority grid-access and the balancing-requirement exemptions given to wind producers in some European countries.
"Renewable-energy generation technologies should be progressively integrated into the market, allowing them to compete on a level playing field with other generation sources," says Huerta. After 2020, the aim should be support primarily through research and development and demonstration funding rather than production incentives, she adds.
Webster says that some wind and renewables support schemes have proven inefficient, encouraging investors to build in places that otherwise would not have made economic sense, and that a more sustainable system is needed if Europe is to exceed 2020 targets. He adds that a market without any priority dispatch for certain plants would allow wind producers to make the most efficient production and dispatch decisions for individual plants.
"We as an industry are fine with being market-responsive, but first you need to tackle the structural market deficits and market distortions," stresses EWEA's Wilczek. He points to the presence of strong power market incumbents — which EWEA believes makes a priority dispatching system necessary — along with the lack of commercial power markets in some countries and the fact that power producers from coal to nuclear receive substantial subsidies. "Do liberalise the market, but do it for everyone," says Wilczek.
One way to make concrete progress in the short term may be to hand to wind generators across Europe the responsibility for balancing market requirements when forecasts are wrong. "In Spain you are a balancing-responsible party and this is not a problem because the system operator has a dedicated control centre using a sophisticated forecasting system that improves the quality of forecasts," notes Wilczek.
"Producers are not afraid of an eventual imbalance penalty because it will be small." The pursuit of best practices like this are key building blocks for integrating ever-increasing amounts of wind into Europe's power mix.