Electricity market design during the energy transition and the energy crisis

The topic of electricity market design has become highly contentious in recent times—particularly in Europe, where there has been a surge in wholesale electricity spot prices due to the exorbitant prices of natural gas. Many point to the market design’s focus on setting a single market clearing price based on the costliest resource required to meet demand, frequently natural gas, as the root cause. Besides the current energy crisis and short-term problems, there is a growing concern amongst analysts that, with the current market design, the extensive adoption of zero-marginal-cost renewable electricity would force wholesale electricity prices down to levels that render new investments unprofitable. The long-term ramifications are now a crucial part of the ongoing conversation in many regions, such as the United Kingdom, where the government has introduced its Review of Electricity Market Arrangements (REMA) to address such concerns.

In a decarbonized, decentralized, and digitized energy system, electricity markets should aim to meet several key policy objectives. These include facilitating the integration of renewable energy sources and distributed energy resources, ensuring security of supply, promoting efficient investment in infrastructure, and enabling the transition to a low-carbon economy. However, there are concerns about whether energy-only wholesale markets, as supported by EU legislation, can efficiently meet these objectives. Incremental reforms, such as long-term contracts and more granular price signals, may help address some of these issues. However, there may also be a need for more structural reform to achieve decarbonization objectives in an efficient way, for instance the introduction of nodal pricing. The role of consumers and distributed energy resources will also be crucial in the new markets, and their involvement may require additional market design changes and indeed new, for instance, local markets. Ultimately, the incremental reform of electricity markets may help address the European energy crisis, but there are also alternative market designs to consider, each with its own strengths and weaknesses.

Given this background, the articles in this issue of the Oxford Energy Forum debate the topic of electricity market design and the ways in which the market should be reformed to meet the dual challenges of the short-term energy crisis and long-term decarbonization objectives.