Today’s release of the final Clean Power Plan by President Obama ushers in an exciting period of change on US power grids. Wind and solar energy will get a big boost through the plan. The plan recognizes that to sustain public support for this strategy, the costs of integrating the new technologies need to be kept down and the grid needs to remain reliable. Several revisions to the draft plan were made specifically to provide time and flexibility to ensure the lights stay on while more clean energy sources join the grid. An important accommodation is carefully phasing in targets.
Much of the US and many countries rely on wholesale markets to help manage electric grids. It’s a good strategy. Well-designed markets can maintain reliability while also keeping costs down. However, policymakers and regulators are faced with a bewildering number of choices to ensure these markets function well.
Fortunately, the US can look to Germany. In Germany, wind and solar already represent 43% of installed generating capacity. While the US is at a modest 7%, some regions are approaching 20% (see graph). The Energy Information Administration projects that under the Clean Power Plan, US-wide wind and solar penetration could reach an overall average of 22% by 2030. Again, though, this masks significant regional variation.
As Max discussed in a recent blog, Germany is also phasing out nuclear energy and accelerating coal’s exit.
German policymakers need to know that with these changes its market will work harmoniously into the future — maintaining reliability and keeping costs reasonable. Fossil fuel power plant owners see problems on the horizon. German energy policies are pushing down wholesale energy prices and could potentially cause fossil fuel power plants to go out of business. As a result, the country could experience shortages and blackouts, say the fossil fuel plant owners.
Concerns about the future have prompted the Germans to review their wholesale markets. American and German policymakers shared their perspectives on this important topic at a recent joint US-Germany Electricity Market Design Workshop held in Berlin, Germany. With support from the US Department of State, I attended the event, which was co-hosted by the German Ministry of Economic Affairs and Energy and the U.S. Departments of State and Energy.
Germany’s electricity market is currently structured as what’s referred to as an “energy-only “ market. In an energy-only market, power plants earn revenues primarily by selling energy. The German government is evaluating whether they should create an additional market, referred to as a “capacity market”.
Power market concepts can be a bit peculiar, so let me try to describe the capacity market concept with an analogy.
Think about milk before the era of affordable refrigeration. Buying energy is like buying milk. You buy it when you need it, perhaps by getting daily deliveries from the milkman. Buying capacity is like buying a cow. When you want milk, your cow can provide it. Except the cow’s milk production doesn’t exactly line up with your needs. You need to buy enough cows to make sure everyone in your family has enough milk for their breakfast cereal. When you have extra milk, hopefully you can find someone to sell it to. Otherwise it spoils. If all your neighbors are selling milk at the same time, you won’t get much for it.
A power market that compensates power plants for energy and capacity is like having consumers pay for milk and also pay an extra amount to sustain the herd of cows. They aren’t your cows, but you happily pay knowing the cows are out there somewhere. When you or anyone else needs milk, these herds of cows are supposed to make it.
On July 3rd the German Ministry of Economic Affairs and Energy completed its deliberations with the release of its White Paper. So far the paper has only been released in German, but an English-language summary is here and the predecessor Green Paper is here.
The Ministry has concluded that a slightly reformed energy-only market—what they are calling electricity market 2.0—will serve the country into the future. The new market reforms will enter legislation in the Fall and reforms will be implemented in 2016.
The Ministry does not buy into the narrative that fossil fuel plants need to be compensated through a capacity market to ensure grid reliability. The Ministry sees other ways to ensure reliability, such as by increasing links to neighboring countries. This would allow Germany and its neighbors to benefit from differences in demand and supply between countries.
The Ministry is also recommitting to not impose explicit or implicit price caps in the energy markets. Flexible power plants can earn revenues by selling energy if prices spike as wind and solar ramp up and down.
How will we know if the Germans made the “right” choice? Ideally, we could run an experiment with multiple Germanys, implement a capacity market in one Germany, but not the other. Maybe we should designate the recently discovered earth-like Kepler-452b for economics experiments like this!
Until NASA takes up my proposal, we’re stuck in the world of observation, theory, and conjecture.
As the German experience unfolds, policymakers in markets such as the US should take a hard look at their own markets. Should capacity market structures be introduced, as was recently debated in Texas? Or should price caps continue to be raised, as the US Federal Energy Regulatory Commission has been urging? Should markets be kept local as in Texas or better integrated with their neighbors, as is beginning to happen in California?
We should continue to keep an eye on Germany.