A Power System Blueprint ‘deep dive’
Solar and wind only cannibalise prices if you let them
Dominic Scott and Bram Claeys
A recurring theme in energy market discussions is the fear that increasing shares of solar and wind with negligible running costs will lead to plummeting electricity prices — so-called price cannibalisation — making further investments in renewables uneconomic.
This has fuelled concerns that investment in renewables — having at last reached cost competitiveness — may yet stall and fail to deliver the required total decarbonisation of the power sector. Merchant investment might be unfeasible. Ever-growing subsidies might be required, and perhaps even these won’t suffice to decarbonise completely.
We find this to be entirely avoidable. And we identify further improvements to build on the strengths of European policy framework.
Policymakers have at least two theoretical options to replace fossil fuels by renewables and other clean resources: either directly subsidise investments or apply carbon pricing. The subsidy route will see the prices these resources capture on the market rapidly falling as more are deployed. This impedes merchant investment and locks policymakers into a further cycle of subsidy, which must encompass more and more sectors — such as flexibility and energy efficiency — to ensure a level playing field. The carbon-pricing route avoids price cannibalisation, but comes with other risks.
We therefore make the case for a hybrid approach between these two theoretical extremes, based on the following policy checklist for deploying renewables in a cannibalisation-free environment:
- Ensure carbon allowances and thus carbon prices are aligned with climate targets.
- Design renewables support in a smart way, to ensure real-time prices are undistorted.
- Remove obstacles to flexibility and invest in interconnection and market integration.
The current European policy framework comes out as a mixed bag. The Emission Trading Scheme (ETS) is effective at putting a price on carbon in the power sector. Recent reforms to strengthen the regulatory architecture should go a long way to easing problematic price cannibalisation. On the second item, ensuring renewables support is smart and the picture is mixed but improving, with growing attention here in the Electricity Market Design (EMD) discussions suggesting promise. The third item, unlocking flexibility, requires substantial further work to make sure price formation is efficient and markets are better integrated.
Table of Contents
A recurring theme in energy market discussions is the fear that increasing shares of solar and wind with negligible running costs will lead to plummeting electricity prices, making further investments in renewables uneconomic.
Studies identify examples where growing penetrations of variable renewables have stimulated reductions in market prices captured by these new resources.
This has fuelled concerns that investment in renewables — having at last reached cost competitiveness — may yet stall and fail to deliver the required total decarbonisation of the power sector. Merchant investment might be unfeasible. Ever-growing subsidies might be required, and perhaps even these won’t suffice to decarbonise completely.
In the current still-elevated price environment, fears about depressed prices may seem out of place. Indeed, we want and expect renewables to be an important part of reducing high prices, mostly caused by expensive fossil gas and the unavailability of nuclear. Nonetheless, looking beyond the current price crisis is fundamental to putting the energy transition on a sustainable path. Our decarbonisation strategy must not critically depend on the assumption that expensive fossil fuels will always remain so or that renewables will forever continue their dramatic fall in cost.
Therefore, to shed light on the matter, this paper addresses three questions at the heart of this concern:
- What is price cannibalisation, including its drivers and effects?
- What options are open to policymakers to ensure price cannibalisation does not impede renewables investment and delivery of a fully decarbonised power sector?
- What is the outlook for price cannibalisation under the existing European market framework?
In answering these questions, we show that price cannibalisation depends on a hybrid policy instrument to force fossil fuels out and renewables into the energy mix, as well as the level of flexibility on both the supply and the demand sides of the system. Overall, our analysis debunks the myth that instances of price cannibalisation show the energy transition is unachievable. If we apply a bit of brains, we argue, the fear of price cannibalisation will eat itself.
1. Market value decline is not an indication that variable renewable energy is hitting fundamental integration limits, because –
- Price cannibalisation is chiefly an outcome of a policy choice to rely on subsidies. This policy uses renewables subsidies or quotas as a substitute for rather than a complement to a carbon price to drive decarbonisation. In particular, price cannibalisation for renewables, including variable renewable energy sources, depends significantly on whether the carbon price is aligned with the required decarbonisation. Hiking up the carbon price drives up renewables capture prices by making energy pricier, when dirty resources also generate, and makes cleaner options more competitive. In contrast, relying on support in absence of carbon pricing to deploy variable renewables pushes out more expensive resources, leads to lower market prices and makes renewables a less attractive market investment.
- Price cannibalisation is not specific to variable renewables. Once a support policy is used to deliver more of a technology — any technology — than market prices will bear, price cannibalisation will become a problem in that market revenues will fall below levelised cost, and merchant investment will struggle. This holds true regardless of the technology’s variability or whether running costs are high or low. These effects may appear particularly pronounced for variable renewables when carbon pricing regime is inadequate — which we explain more fully later.
- Price cannibalisation need not necessarily obstruct the rollout of renewables. More renewables can still be deployed. But to be clear, if policymakers opt to rely solely on support, rather than seeing it as a complement to carbon pricing, then the public must pay out ever more in subsidies for renewables, as well as for flexibility and — in order to maintain a level playing field — energy efficiency, all of which will entail complexity and expense, crowd out market investment in these resources and embed government intervention.
2. A hybrid approach offers the best of both worlds, one that builds on a robust carbon price and complements this with well-designed renewable support.
- Carbon pricing ensures that the market provides optimal remuneration for clean resources, while the support scheme may be designed to target reductions in the cost of capital and minimise market distortions.
- A hybrid approach can limit system cost, limit risk of misinterpreting market signals as an indication that variable renewables are reaching fundamental integration limits, leave some space for merchant investment and minimise government intervention and regulatory complexity.
3. We therefore grade European policymakers’ efforts in designing a well-functioning regulatory architecture as a mixed bag. In Table 1 in the question 3 section, we assess the current European market design and regulatory framework, grading efforts from “very positive” (carbon pricing regime) to “mixed but improving” (renewable support design) to “significant challenge requiring attention” (demand-side flexibility, system integration, cross-sectoral integration) — noting that the reform efforts are largely going in the right direction.
- The Emission Trading Scheme (ETS) as a carbon pricing architecture is a strength — at last putting a robust price on carbon.
- The carbon price sends efficient signals for investment in renewables, in flexibility to accommodate their variability (discussed further later) and for efficiency in consumption decisions.
- Continued tightening of the emission allowance quota will be important, as well as the end of fossil fuel subsidies, and a socially just extension of carbon pricing to other sectors.
- Although the framework can be improved, Europe offers a model that other jurisdictions, such as the United States and India, can draw on in developing a framework to place a price on carbon.
- Attention is at last turning to designing renewables support in a smart way.
- The European Commission proposed a targeted reform of the Electricity Market Design, which offers an opportunity to embed smart renewables support.
- Contracts for differences should be designed to ensure against unnecessary price cannibalisation and limit the role of support to that of a risk insurance that lowers financing cost.
- Design features include ensuring that spot prices set the incentive to produce, achieved by delinking the support paid from actual energy offered.
- Much attention is required to enabling flexibility.
- Flexibility is key in reducing the cost of the energy transition, including in the form of expanded interregional transmission (incentivised by more granular locational wholesale pricing), integration across sectors (electrification) and the unlocking of accompanying demand-side and storage flexibilities, including through transport and heat electrification.
- Flexibility will only grow in importance as we head towards the decarbonisation endgame, such as from 80% to 100% decarbonised, and indeed without it, it will be impossible for either RES support or ETS to deliver full decarbonisation. Fortunately, carbon pricing sends the signals for exactly the type of flexibility the decarbonised system needs by making the remaining fossil fuels on the system increasingly expensive and underpinning the profitability of new flexible resources that flex abundant, cheap and clean energy to when and where needed.
4. Finally, price distributions in a system with high renewables penetration need not be very different from current distributions — in the presence of a robust carbon price, well-designed support and system flexibility.
- Even in a system based entirely on carbon-free technologies with low marginal cost, prices need not alternate between near zero during variable renewables abundance and very high levels during variable renewables scarcity, so long as system flexibility is enabled and incentivised.
- This is because flexibility — stimulated by carbon prices and unlocked by complementary regulatory action — helps to pushexpensive fossil-fuelled generation out of the system and allows storage, demand response and transmission arbitrage to set prices with demand bids when variable renewable energy is abundant and supply bids when scarce.
- As such, the distribution of hours per year in which these technologies recoup their costs does not have to change radically as the carbon budget is lowered in presence of flexibility: the fear of price cannibalisation can eat itself — if we apply a bit of brain.
Question 1. What is price cannibalisation, its drivers and effects?
What is it?
We define price cannibalisation as the reduction in market prices and thus value captured by a particular resource that occurs as more energy is added from that resource. It may be considered problematic when prices and revenues captured fall below those required to recover lifetime costs while, simultaneously, more of the resource would be of value to the system.
Some academics have argued cannibalisation may affect variable renewables as they “face a substantial difficulty in becoming economical at high market shares … [and thus] without fundamental technological breakthroughs, a deep decarbonisation of power systems will be hard to achieve based on wind and solar power alone.” Indeed theoretical analysis shows that the growth of variable renewable energy (VRE) in the power system can depress market prices when they are deployed and lead to prices of zero or below. Where for example wind capacity is already significant, holding other variables constant, adding more wind capacity means more production is concentrated in those hours when potential wind production is highest, disproportionately lowering the volume-weighted prices realised by both new and existing wind plants.
But price cannibalisation is not just a theoretical abstraction. Real world analyses have identified its presence. Analysis of wholesale prices in California from 2013-2017 finds both absolute and relative cannibalisation effects for both solar and wind, with these effects growing with penetration. A recent analysis of price cannibalisation in Germany over 2015 to early 2021 confirms the presence of price cannibalisation: more solar and wind production led to lower capture prices, with pronounced and non-linear effects (see Figure 1).
Figure 1: Market value (Euro per MWh) of wind and solar renewables against generation forecast, Germany, 2015-2021
Source: Liebensteiner, J., & Naumann, F. (2022, November). Can carbon pricing counteract renewable energies’ cannibalization problem? Energy Economics, 115.
At first sight the driver is more renewables: more zero cost renewables equal more cannibalisation.
But recent contributions to the academic literature shed light on an important nuance — that the extent of price cannibalisation hinges crucially on the policy tool used to drive decarbonisation and deployment of renewables, as well as the role of flexibility, which we dive into later.
A distinction here is drawn between two policy tools:
- Carbon pricing. This can be achieved by imposing a carbon tax directly or by setting a price on carbon with the introduction of tradeable carbon allowances.
- This might be in the form of a subsidy for renewables through a revenue stream additional to the electricity market, such as a feed-in tariff. But it could also be another policy that target a certain amount of renewables beyond what market prices would bear, such as a contract for .
To illustrate the role of each of these, the analysis that follows considers the extremes of relying on just one of these tools. This is not representative of the policy landscape, which in Europe encompasses both carbon pricing and renewable support, but it is helpful in disentangling the effect of each tool. We build on this in the final section to apply analysis to the real world.
Carbon pricing and renewable support compared
On the one hand, use of a carbon price to drive decarbonisation and deployment of renewables will not stimulate a price cannibalisation that impedes optimal deployment of renewables: the value that renewables capture in market prices will not dip below their levelised cost. Research shows this result holds in a power system model with high penetrations of solar and wind, such as above 80%. Why? Because carbon emissions are reduced to the point where the cost of reducing the last unit of carbon is equal to the carbon price. This stimulates market prices when energy is being generated from unabated fossil fuels, and the accompanying higher prices benefit renewable generators when they generate at the same time. It also stimulates demand — the price offered — for clean energy from renewable energy where it can be enabled through flexibility such as storage and new wires. Note: Europe already has instituted tightening carbon quota through the Emissions Trading Scheme, which should stimulate a growing carbon price trajectory.
On the other hand, relying alone on support that directly subsidises renewable energy — or that sets renewables generation technologies beyond a level that market prices would bear — will lead to price cannibalisation. By definition, market prices captured by VRE will not cover the levelised costs of renewables. Support policy can depress market prices through two mechanisms:
- When the subsidised renewable technology is generating, the larger share of this low marginal cost technology pushes down prices, even when the technology is not price setting by displacing more expensive resources.
- When a subsidy is linked to energy produced and the subsidised technology sets prices, the subsidy reduces the break-even point of the marginal producer by the extent of the subsidy and may stimulate a negative market price. (This might be dubbed the subsidy design price cannibalisation effect as it can be tempered by smart subsidy design, a point we return to later.)
Price cannibalisation is an outcome of the policy choice to use subsidies — whether explicit or implicit through setting a given level of renewables — as a substitute for carbon pricing to spur decarbonisation and renewables deployment
The first effect is counteracted by pricing carbon, which, for a given carbon quota, will rise until prices earned by renewables (in consort with flexible resources like storage) are sufficient to recover their levelised costs. The second effect is present neither with a carbon price nor with a well-designed renewable support.
For the case of renewables support without carbon pricing, as renewables penetration grows so, too, does price cannibalisation. Modelling suggests that at 50% penetration, the market value captured by variable renewables can fall to zero, such that subsidies become their only revenue source. (This finding draws on a simplified model of Germany, Poland, France, Netherlands and Belgium.)
Thus, how pronounced any price cannibalisation effect is for variable renewables depends on the carbon price: the lower the carbon price, the lower will be the level of penetration that price cannibalisation will kick in at for carbon-free resources such as variable renewables.
A number of additional factors are important here in facilitating or impeding the extent of the cannibalisation effect.
The first is that as more flexible resources — storage, conveyance through wires, demand response — are added to the system, the renewables penetration rate at which market value declines to zero increases. In this way, flexibility slows down the speed of price cannibalisation. We return to flexibility in answering question 2: what policymakers can do.
Other factors identified as having further facilitated price cannibalisation in Germany in recent years include absence of demand growth and low or falling input prices, such as the price of natural gas. The wider literature identifies other drivers, including fossil fuel subsidies. Finally, note the investment-chilling impact of a given market price reduction is lessened as the levelised cost of renewables falls. We treat these variables as constant for the remainder of the paper in order to focus on levers more directly under the influence of policymakers.
A renewables thing?
When carbon pricing is not aligned with, or trails behind, the desired decarbonisation trajectory and support framework for renewables, the variable nature of some renewables make cannibalisation effects particularly troublesome. This is because variability deprives these resources access to high prices during system scarcity — scarcity will increasingly occur when they are not generating.
In time, investments in flexibility can address decarbonisation effects, but in absence of a carbon price consistent with the required decarbonisation trajectory, it is not evident there will be a signal for the full extent of flexibility required by the system, in turn necessitating subsidy for flexibility.
 See RAP’s deep dive on contract for difference (CfD) design, which discusses smart support designs such as financial CfDs and capability CfDs. Insert link.
Price cannibalisation is not specific to variable renewables.Although supply variability can contribute towards the speed of decline, price cannibalisation is not specific to variable renewables. Research shows the decline of market value under a support policy can happen for other technologies, most dramatically for those with very low dispatch costs. For example, a support policy for nuclear pushes its penetration above that supported by the market and sees its market value fall below the point of cost recovery. The success of the subsidy leads to nuclear cannibalising its own market revenue.
Price cannibalisation effect is not specific to variable renewables. ... For example, a support policy for nuclear pushes its market value below the point of cost recovery, causing it to cannibalise its own revenue.
In sum, price cannibalisation happens when support is used directly to substitute for market mechanisms (carbon pricing) to jam in more renewables and is exacerbated by system inflexibility.
Absence of a fit and proper price on carbon has been identified as a key driver of price cannibalisation. The main drawbacks and risks of price cannibalisation link to complexity, expense, the crowding out of merchant RES investment, necessity to provide support for flexibility, impeding demand response and misdiagnosis. We go through each of these.
Support policies increase the share of low-emission technologies. When they are added to a system with fossil-fuelled energy, they displace the most expensive resources — thus adding more reduces their average market revenue. Furthermore, absence of a carbon price allows fossil-fuelled alternatives to remain competitive and limits the value available to investments (such as through storage) that can erode the share of dirty energy through the flexing of abundant clean energy. As a result, these flexible technologies need to be compensated outside the market, and the necessity of support becomes self-perpetuating. All of this risks killing off merchant investment in RES.
Reliance on subsidy contributes to complexity, which will grow as innovative new technologies must be accommodated and as other sectors are integrated. This can be compared with carbon policies that raise market prices when fossil-fuelled generators are running, encouraging low-emission generators into the market, leaving investment to the market and thus decentralising the energy transition.
With subsidies, support becomes self-perpetuating — subsidy necessitates more subsidy.
What about expense? Both approaches entail cost: consumers (or taxpayers) finance renewables subsidies and they also pay for carbon pricing. Nevertheless, analysis suggests using subsidy support as a simple substitute for a carbon price makes the transition more expensive because a carbon price drives implementation of the cheapest measures to reduce carbon emissions. This might include efficiency measures in consumption, shifting from coal to gas and a multitude of other decentralised decisions that renewables subsidies alone do not stimulate. Furthermore, mechanisms to finance these subsidies are prone to lobbying and special interests and can lead to outcomes that might be considered unfair. For instance, Germany’s EEG renewables surcharge (abolished in 2022) targeted smaller consumers to subsidise big corporate energy consumers.
Perhaps the biggest concern is policymakers potentially concluding that price cannibalisation means variable renewable energy is hitting fundamental integration limits. This conclusion would misdiagnose the causes of price cannibalisation and would risk derailing the energy transition. Policymakers should not see market value decline under variable renewable support policies as an indication that variable renewable energy is hitting fundamental integration limits.
Policymakers should not see market value decline under variable renewable support policies as an indication that variable renewable energy is hitting fundamental integration limits.
Question 2. What options are open to policymakers to ensure price cannibalisation does not impede renewables investment and delivery of a fully decarbonised power sector?
Setting a carbon price that is consistent with the required decarbonisation trajectory is the game changer. Any complementary support for the rollout of renewables should be consistent with the same decarbonisation trajectory. This calls for joined up hybrid policy.
Getting carbon pricing right
In Europe, reform of the Emission Trading Scheme is helpfully ensuring that the carbon quota tracks more closely to the trajectory required to decarbonise the EU power system. This has stimulated carbon prices. Continued tightening of the carbon quota is necessary to underpin the required decarbonisation trajectory. Figure 2 illustrates the important influence of carbon pricing in shaping prices captured by variable renewables. Note the upswing in both carbon price and market values in 2018, and furthermore that carbon prices have jumped by a multiple since 2018.
Figure 2: Market data from Germany, 2010-2018
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Adding smart support for a hybrid approach
A hybrid approach, which combines a robust carbon price with a support scheme, offers the best of both worlds. If the carbon price is sufficiently high to ensure prices align with the decarbonisation trajectory, then the subsidy for a given share of variable renewable energy can be close to zero. This provides minimal market distortion, costs consumers very little and reduces investor risk and thus lowers financing costs.
The carbon price is the game changer — but this can be combined with well-designed renewable support in a hybrid approach that offers the best of both worlds.
Smart design of support policies can also help to limit introduction of market distortions — notably to limit the subsidy design price cannibalisation effect. Design features include decoupling subsidy volume remunerated from actual metered output and thereby ensuring spot prices set the incentive to dispatch.
Smart design of support policies can help to limit introduction of market distortions — notably to limit the subsidy design price cannibalisation effect.
Removing obstacles to flexibility
Another essential policy measure is to remove obstacles for providing flexibility.
As renewables penetration grows, the value the market assigns to flexibility will grow, as will the importance that prices accurately signal this value. This is supported with a market design that reflects all costs at the margin and in as much granularity in time and location as possible. Efficiently formed prices and tariffs send the signal to innovative solutions that offer flexibility in time (such as storage or smart demand) and space (as conveyed by interconnected grids) to take advantage of cheap energy when it is abundant and reduce consumption or store energy for consumption later when it is pricey and scarce. A fit and proper carbon pricing regime is an essential element to efficient price formation, which will send signals to the market to bring forward the flexibility the system needs, so long as not impeded by other barriers.
Unlocking flexibility requires requires investment in interconnection and enhanced integration across Europe to shift abundant clean energy from one location to another, according to the weather. With the Trans-European Networks for Energy policy, Europe has a process for investing in projects of common interest, but obstacles, including sufficient resourcing and addressing public acceptance issues, must be overcome.
Cross sectoral integration such as electrification of mobility, power to heat, or power to gas offers the opportunity to unlock valuable new flexible opportunities. Newly electrified demands offer great potential for flexibility as they can avoid additional positive net loads by switching between electricity consumption and the conversion of chemical energy carriers to meet their final energy demands in the heat, industry and transport sectors, and shifting demand over time with thermal storage systems. The extension of the ETS to these other sectors is important and welcome in helping to unlock these synergies. Other policies will be required to overcome the multiplicity of non-price barriers, and investment is necessary in infrastructure to support smart consumption, such as smart meters.
Removing barriers to flexibility — through proper price formation, investment in infrastructure and technology, interconnection and integration across borders and removal of barriers for integration across sectors — will bring about many positive effects. It will reduce:
- The number of hours of market-based curtailmentcurtailment The reduction of power output of specific generators by the system operator on grounds of maintaining grid stability and system safety, often in exchange for compensation. of renewable energy sources.
- The carbon price required to decarbonise our economies and the expense required for variable renewable support policies to reach a given penetration level. (The carbon price rises from 55 €/tCO2 at 50% to 165 €/tCO2 at 100% penetration, less than the climate damages of 195 €/tCO2 estimated in 2020 with a 1% rate of time preference.)
- The overall cost of the energy transition.
Flexibility reduces subsidies required to reach a given penetration of renewables and allows a given abatement level to be achieved with a lower carbon price, thus reducing the cost of the clean energy transition.
This suggests the following checklist for deploying renewables in a cannibalisation-free environment:
1. Align carbon allowances and thus carbon prices with the decarbonisation trajectory.
2. Ensure smart design in renewables support, such that the incentive to dispatch is determined by real time prices, including by decoupling support from metered output.
3. Remove obstacles to flexibility:
a. Integrate demands across sectors and unlock accompanying flexibilities.
b. Ensure efficient price formation.
c. Invest in interconnection and enhance market integration across jurisdictions.
Figure 3 shows how prices could evolve during the process of decarbonisation in a carbon price regime as flexibility is enabled from electrification of the heat sector and country energy systems are integrated with each other. It shows potential for a very low incidence of zero prices, as well as multiple increases in price — stemming from the multitude of flexibility options — rather than one dramatic jump from a majority of zero-priced hours to occasional extremely high prices. It also shows integrating countries with each other allows for lower prices.
Figure 3: Simulated price duration curve with heat sector integration and cross-country integration in decarbonised European power sector
Source: Böttger, D., & Härtel, P. (2022). On wholesale electricity prices and market values in a carbon-neutral energy system. Energy Economics, 106.
Figure 4 suggests that with application of a growing carbon price to decarbonise the system, along with policy action to unlock flexibility, there need be no foundation to the concern that prices in a system based with significant wind and solar will alternate between zero during variable renewables abundance and very high levels during variable renewables scarcity.
Figure 4: Simulated price duration curves for carbon policies for different average system carbon emissions, with flexibility from storage and transmission reinforcement, Europe
Source: Brown, T., & Reichenberg, L. (2021, August). Decreasing market value of variable renewables can be avoided by policy action. Energy Economics, 100.
As fossil-fuelled generation is pushed out of the system, storage and transmission arbitrage start to set the prices with demand bids when variable renewable energy is abundant and supply bids when variable renewable energy is scarce. The distribution of hours per year in which wind and solar recoup their costs does not change radically as the carbon budget is lowered within a flexible system.
Price distributions need not be very different with high penetration of renewables — helped by a robust carbon price, smart design of renewables support and the unlocking of flexibility.
What kind of carbon price might be required to decarbonise the system? The modelling above suggests a carbon price of 200 euro per tonne emitted is sufficient to achieve around 75% renewables penetration, while more recent analysis suggests that a carbon price of 180 euro per tonne emitted may be sufficient to fully decarbonise the European power sector by 2039. A quick comparison with recent carbon prices, which hit a peak of 100 euro per tonne in February 2023, suggests that policymakers need not baulk at deploying this tool.
Question 3. What is the outlook for price cannibalisation under the existing European electricity market framework?
Having outlined the options available to policymakers to ensure price cannibalisation does not impede renewables investment and delivery of a fully decarbonised power sector, this section assesses the extent to which those options are deployed to their full potential in the current European market design and regulatory framework.
Table 1: Assessment of enablers to limit price cannibalisation
Reality check — assessment in Europe
Emissions Trading Scheme (ETS) — shrinking carbon allowance puts a price on carbon
Agreement on ETS revision of December 2022 puts CO2-emission reduction trajectory for the power sector in line with zero emissions by 2035. The deal also includes establishing a separate ETS for buildings and transport, alongside power and industry Further reforms will nevertheless be necessary to put it on a solid footing for the decarbonisation endgame. (These may include improving the Market Stability Reserve mechanism and improvements in accounting and monitoring of carbon removal credits .) Summary: very positive
Smart design of renewable energy sources (RES) support — to avoid distortions
Current support landscape is very fragmented across RES technologies and between Member States. Recognised best practice is double-sided contracts for difference (CfD). Most existing support schemes are on the spectrum between feed-in premia, tradeable certificates to one-sided CfD. Proposed reform of the Electricity Market Design (EMD) by the European Commission introduces auctioned 2CfD as a standard support scheme and stipulates that market distortion needs to be avoided, though without spelling out details on the desired CfD design. RAP spells out its recommendations here in our deep dive on smart CfDs. It remains to be seen if the new regulation after negotiation with Council and Parliament will be more prescriptive and in which direction. As CfDs are not proposed to be mandatory for existing assets, the distortive effect of legacy support schemes remains in place, unless they are motivated to shift to a 2CfD, or their support scheme runs out. On the other hand, current variable renewable energy source levels remain limited, therefore also the impact of current subsidy schemes remains within limits. Summary: mixed but improving
Unlocking flexibility (1): Efficient price formation
Short-term markets properly reflect temporal system value, as well as scarcity to some extent. Reserve scarcity pricing is, however, not administratively assured. Locational price signals are absent in most European energy markets. Only a few markets have bidding zones of some granularity (Italy, Denmark, Sweden, Norway). Locational marginal pricing is under discussion in the UK. Bidding zonebidding zone The largest geographical area within which market participants are able to trade electricity without network capacity allocation. reform for Germany is proposed by ACER. Summary: mixed but improving
Unlocking flexibility (2): Digitalisation infrastructure
Smart metersmart meter Smart meters provide electricity customers and their suppliers with accurate, near real-time information on consumption and/or generation that allows for managing their consumeption better and engaging in demand-side flexibility. It allows DSOs to have better visibility of their networks. rollout in Europe is progressing but slow. Member States still need to fully implement the Clean Energy for All package, which will help. EMD reform proposals may further incentivise system operators better to account for and mobilise local flexibility in their grid management. Summary: mixed but improving
Unlocking flexibility (3): Access for demand-side flexibility (DSF) and storage
Market participation by DSF aggregations remains problematic in most EU markets, both energy and capacity. Proper implementation of the CE4ALL package would offer important progress. The new EMD reform proposals add positive elements, such as a lower bid size threshold for balancing markets. This is not included for capacity remuneration mechanismscapacity remuneration mechanisms A regulatory scheme under which payments are made to generators, load and storage (and often interconnectors) to provide capacity availability during a specific time period (to top up revenues earned in energy markets) with the aim of ensuring resource adequacy. Costs are usually recovered from customer bills via retail suppliers. (CRMs). Member States may have to establish an indicative objective for DSF and storage and can decide to put in place a dedicated flexibility support scheme. Consumer willingness to participate in DSF products remains a barrier. Automation, standardisation, consumer-centric retail product design and energy communities offer potential to overcome this barrier. ETS2 establishment will require significant efforts to ensure fairness and equity necessary to secure public support. Summary: significant challenge requiring attention
Unlocking flexibility (4): System integration across Europe through interconnection and market coupling
The Trans-European Networks for Energy process for investments in projects of common interest is well established; however, Investments in transmission infrastructure are slow, struggle with public acceptance, and require more resources. The energy crisis demonstrated in stark terms how important interconnections are to keep the lights on (e.g., France): this will hopefully speed up projects. Summary: significant challenge requiring attention
Unlocking flexibility (5): Cross-sectoral integration — electrify sectors, harmonise price signals and regulatory treatment and unlock flexibility potential
Big area for improvement. The building renovation sector is beset by market failures and barriers. Some progress through expanded ETS (ETS2) towards a harmonised CO2 price. Tariff methodologies and levy policies vary widely between energy vectors and MS, and significant harmonisation is not in sight. Some positive steps include EV-flex provisions in the Alternative Fuels Infrastructure Regulation. V2G remains a challenge. Summary: significant challenge requiring attention
Table 1 shows the ETS framework is the most positive single element in existing arrangements — though action here poses more of a challenge in other jurisdictions. India, for example, does not have a national framework to place a price on carbon. In the United States, even states with carbon pricing in places, such as California, can help put renewables deployment on a more solid footing with reform to underpin a more robust price on carbon (California’s carbon price is about $30/tCO2, not enough to remedy its price cannibalisation problem). Growing attention in Europe to promising smart CfD designs suggest the policy landscape may be heading in the right direction for RES support. Much work is needed in unlocking flexibility. Sustained efforts this decade must include unlocking demand-side flexibility, introducing locational price signals, integrating markets across Europe and unlocking flexibility potential of newly coupled electrification demands.
Price cannibalisation is a feature of excessive reliance on subsidies to roll out variable renewables. The approach we propose ensures carbon prices are aligned with the decarbonisation trajectory, ensures smart design of renewables support, unlocks flexibility, preserves market signals for renewables deployment and supports the transition to a clean energy future at least cost and with minimal government intervention. With such an approach, price cannibalisation need not be inevitable: the distribution of hours per year in which wind and solar recoup their costs need not change radically as the carbon budget is lowered.
We find that in Europe policies for placing a sizeable price on carbon are relatively strong, an essential building block for a market free of price cannibalisation. With the European Commissions’ Electricity Market Design proposals, attention is helpfully turning to ensuring that support schemes for renewables are efficiently designed. We spell out desirable design features in detail in our deep dive on contracts for difference. Much further attention is required to unlock flexibilities, particularly of demand-side flexibility, across jurisdictions and across new coupled energy vectors.
In time, and with appropriate action now, we may look back upon the early 2020s as the moment when we forgot our worries about price cannibalisation. If we apply a bit of brains, we argue, the fear of price cannibalisation will eat itself.
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Thanks to Monika Morawiecka, Michael Hogan, Zsuzsanna Pato, Sophie Yule-Bennet, Andreas Jahn, Tim Simard, and Deborah Bynum at RAP, and Tom Brown at the Technical University of Berlin for comments. All mistakes are the authors’ own.