Market Design for Long-Distance Trade in Renewable Electricity.

AuthorGreen, Richard
  1. INTRODUCTION

    Europe has adopted ambitious targets for renewable energy: 20% of all its energy consumption in 2020, and 27% in 2030. Meeting these will imply a significant expansion in the amount of wind and solar generation across Europe. The output obtained from a given investment in capacity depends strongly on where that capacity is located, since wind speeds and solar insolation vary significantly across Europe. Given that both technologies are still relatively expensive, the advantages of deploying them mainly in areas with good potentials, in order to minimise the capital cost per unit of renewable output, ought to be clear.

    If renewable output in many regions of Europe is thus dominated by either wind or solar capacity, it is likely to vary more over time than with a more diverse mix. This will exacerbate the well-known problems of intermittency, and steps must be taken to deal with this. One option is to build spare capacity to act as a back-up for times when the renewable generators are not running; an alternative is to use transmission links to other countries to get the benefits of diversity.

    Europe is building a Single Electricity Market, which should facilitate international trade in renewable energy. The aims of this paper are to estimate the benefits of using international trade in renewable energy to allow more renewables to be deployed in areas with higher resources, and to assess the challenges involved. We use an engineering model of the European power system (WeSIM) to calculate the amounts of transmission capacity and peaking power stations needed to allow a secure, optimal, dispatch in two scenarios. One is based on a national deployment of wind and solar power, as in (Booz, 2013); the other has the same amounts of wind and solar output (in TWh over the year) but obtains them from less capacity, concentrated in areas with greater resource.

    We find that it is possible to save 73 GW of wind capacity (16%) and 16 GW of solar capacity (8%) by deploying them in more suitable areas. This would bring a saving of [euro]14.7 billion a year in 2030 (in 2012 prices): [euro]18.9 billion gross savings offset by [euro]4.2 billion additional costs to deal with greater intermittency. This is made up of [euro]0.9 billion in extra fuel and operating costs, [euro]0.3 billion in extra peaking capacity and [euro]3 billion in additional transmission.

    Despite the extra investment, the transmission lines between regions are frequently congested, even within countries, suggesting that market-splitting will be required inside countries alongside market coupling between them. Peaking generators will have very low average load factors, and if they depended on market prices to cover all their costs, their profits would be volatile, reacting to each year's weather. A cross-border capacity market might be a suitable way to reduce their risks and to share the burden of paying for these stations, although it might be hard to reconcile this kind of sharing with the natural desire to have "reliable" local generators available when system conditions are tight. We also find that while the overall savings from coordinating renewables are worth about 5% of the cost of generation and transmission, some countries are likely to lose, unless a carefully-designed renewable certificate trading scheme provides transfers to those building additional high-cost capacity.

    If countries are to obtain a significant proportion of their renewable electricity from schemes outside their borders, they are likely to want confidence that this power can actually be consumed by the people paying for it. We show that a system of Financial Transmission Rights could offer this reassurance, and would be more flexible in practice than relying on the link-by-link physical rights that have demonstrated electricity trading in Europe to date.

    The next section discusses the background to our work. Section 3 describes the model and its data, and section 4 presents the results. We discuss some of the implications for market design in section 5, and offer summary conclusions in section 6.

  2. BACKGROUND

    The principle of trade based on comparative advantage goes back to Ricardo, and applying it to either the electricity industry or to environmental problems is hardly a new idea. Countries have traded power across borders for decades, and Nord Pool has had a formal international wholesale market since 1996. Even before Nord Pool was established, the hydro-based systems in Norway and Sweden would tend to import power from Denmark and Germany in dry years and export it when they had plenty of water. While the availability of hydroelectricity varies from year to year, wind outputs vary from hour to hour. Denmark was the first European country to source a high proportion of its electricity from wind, and duly exported more electricity (or imported less) in hours with above-average wind output, compared to the monthly norm for that time of day. This allowed it to deal with the intermittency of wind output at a relatively modest cost (Green and Vasilakos, 2012).

    The traditional approach to environmental regulation involved setting standards for every source of pollution and perhaps allowing them to vary if different sources faced different costs of clean-up; the newer approach of environmental markets can allow polluters to meet an overall cap on pollution in an efficient manner by trading. The US Acid Rain Program was an inspiration for the EU Emissions Trading Scheme (EU ETS), which has succeeded in keeping Europe's carbon emissions down to the level agreed by its governments. Unfortunately, the EU ETS has not been able to maintain a price at a sufficient level to encourage investment in low-carbon generation. (1) Achieving the EU's targets for renewable energy therefore requires direct intervention, mainly in the form of national feed-in tariffs or tradable green certificate schemes.

    When the European Commission set national targets for renewable energy in 2009, it was aware that Member States differed in their renewable resources and the extent to which these had already been exploited. The starting point for these targets was therefore to increase the share of renewable energy in each country by the same amount, although those numbers were immediately adjusted to require richer countries to do more and the poorer ones to do less. The Directive also allowed a country with a demanding target, relative to its renewable resources, to develop joint projects with another country (inside or outside the EU) and share the renewable energy produced or simply to use a statistical transfer from another country that had over-achieved its target. These mechanisms are similar to the Clean Development Mechanism (CDM), established to allow companies and governments from industrialised countries to offset some of their carbon emissions by supporting projects in developing countries. As of March 2015, nearly 8,000 CDM projects with potential emissions reductions of 8 GT of carbon dioxide by 2020 had been registered (UNFCCC, 2015).

    In contrast, almost all the proposals for cooperation under the EU Renewables Directive are still hypothetical (Klessmann et al. 2014). One reason for this is that most EU countries seem to prefer schemes within their borders which have a greater prospect of creating "green jobs" than those further afield; (2) getting voters to pay for an expensive power station in another EU country does not appeal to most politicians. Even if the principle can be agreed, Soderholm (2008) shows that a number of practical problems had to be solved to create the rare cross-border tradable green certificate market between Sweden and Norway (which is, of course, outside the EU but covered by many EU Internal Market rules).

    The lack of practical progress has not deterred academics from studying the gains that might be achieved from greater coordination across Europe. Aune et al (2012) estimate that using an EU-wide certificate trading scheme would save 70% of the cost of implementing a 20% renewable energy target, measured in terms of economic welfare. They point out that while certificate trading could equalise the marginal cost of renewable production, the marginal value of electricity consumption will vary (inefficiently) between countries if they have different national targets for the share of renewable energy. This is because a higher national target implies that the cost of a larger number of certificates have to be added to the price of each unit of electricity, and different targets will produce different prices, even if the marginal cost of power is the same. Unteutsch and Lindenberger (2014) calculate lower savings (41-45%) from coordination while reaching a 55% renewables target by 2030, using the more common metric of system costs (and ignoring the knock-on welfare effects from higher prices). This is worth between [euro]57bn and [euro]73bn over a ten-year period; Booz et al (2013) find savings of [euro]15-30 billion per year by 2030.

    The European Commission (2015) points out the importance of increasing interconnection. Its target is that every member state should have cross-border transmission equal to at least 10% of its installed generation capacity. Zachmann (2013) points out that the gains from increasing interconnection are particularly significant when countries with high shares of renewables can coordinate the back-up capacity needed, but also discusses the barriers to this coordination. Saguan and Meeus (2014) use a stylised model to predict that some national planners may have an incentive to build less transmission than would be optimal for Europe as a whole. Our main simulations assume that neither national self-interest nor local opposition to new lines prevents transmission from expanding optimally.

  3. MODELLING AND DATA

    We combine three different models to simulate the impact of better coordinating the deployment of renewable...

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