Week 7 - Chapter 12 Flashcards
- competitive market
When multiple technologies share key value-driver characteristics (i.e., are available in the same place, at the same time, and with the same degree of reliability or dispatchability), they can be thought of as substitutes for a given application. This sets up the dynamic of a competitive market. When technologies differ materially across some of these fungibility dimensions (i.e., are not available in the same place, or target energy vs. capacity), they do not meet in the marketplace and therefore should not be thought of as competitive technologies.
- wholesale electricity markets
Wholesale electricity markets, specifically for electricity sold in real-time and day-ahead markets, are among the easiest to understand. Very formal structures are set up by grid operators to procure energy from various generators. Once a generator is qualified to provide electricity to the market at a very specific place and time, deciding among the generation options is a matter of a structured auction system. Traditional generators, including fossil fuel, nuclear, hydropower, and other renewable generators, all bid into these short-term markets when and where they are available, and those with the lowest marginal cost are chosen first until the demand is met. Once they are winners in the market, they are obligated to dispatch their energy when and in the amount expected.
Since these markets operate continually, they include the needs for all base, intermediate, and peak power times. Based on the relative cost structures and value drivers of the supply options, different technologies are more suitable to meet different energy needs.
- forward markets
Forward markets allow the procurement of electricity under large long-term contracts and are designed to ensure that generators can recover their average costs, including a fair return on their investment. This is often necessary to induce the operator and capital providers to fund and build the project. Sometimes these contracts are necessary because the intermittent nature of the resource (including wind and solar projects) prohibits the operator from participating in the dispatchable wholesale energy markets.
- requests for proposals (RFPs)
Procurement for these markets through electric utilities or directly to large customers is typically set up with very specific bid processes, to which any qualified supplier can bid. The rules on these procurements (including bids or requests for proposals, or RFPs) are not always standardized, and many allow flexibility in the character (and therefore the value) of the energy provided. These can be set up to solicit technology-specific procurement, such as wind or solar. Alternatively, the forward contracts also may result from bilateral negotiations necessary to induce building a specialized power plant, such as nuclear or hydropower projects. In general, forward markets for energy are much more heterogeneous and uniquely structured than the shorter-term wholesale energy or capacity markets.
- capacity markets
Capacity markets, where formalized, tend to be highly structured and very specific in the method of engagement for prospective suppliers, just like other wholesale power markets. Many of the generation technologies bid into these capacity markets, which allow them a supplemental revenue stream to their energy sales.
In some of the more highly restructured US wholesale markets, the opportunity to supply capacity has been expanded to accommodate third-party demand response, but the method of supply and the appropriate compensation method are still being determined and sometimes litigated. Setting up these rules would help other solutions emerge to fill the needs as well, including more grid-scale storage as its costs fall and its value improves.
- ancillary service markets
Ancillary service markets are also highly structured, where they exist, but are not as fully developed as energy or capacity markets. In addition to the standby fossil generators and hydropower spinning reserves available to meet these system regulation needs, emerging storage technologies, particularly high-power applications like flywheels, are being explored.
As mentioned in Chapter 4, some of the recent changes in rules for providing ancillary services have bifurcated the slow response and fast response markets, thereby adding more gradations of time and uncertainty, which can improve compensation for devices that can take advantage of them with fast response, such as most emerging storage technologies.
- distributed generation markets
Distributed generation markets are potentially huge, but uncertainty remains on how strong customer demand will be, if there are any confounding regulatory variables, and how intermittency will be managed. As mentioned above, the market structures here are virtually nonexistent. Customers usually decide whether they want to purchase distributed generation based on options available to them from third-party installers of developers, and they often decide based on comparing the cost of the DG solution against the incumbent electricity from grid operators. This can be further complicated if integrating the two has economic or technical ramifications or risks. Third-party providers have created innovative financing and payment structures that allow customers to mitigate some of this risk through a lease payment, though adding financial intermediaries can increase the cost of the delivered electricity.
Given the relatively discrete nature of these customer and supplier interactions, suppliers of any of the DG technologies can offer their services to customers, subject to regulatory restrictions on interconnection when connecting them to the grid is necessary. Specific technologies that have been successful in establishing DG markets include grid-connected distributed solar on homes and businesses, and lots of off-grid applications with various generators (wind, water, and solar) along with some storage. These technology providers retain the option of going directly to customers to establish market opportunities, though doing so invariably incurs higher individual transaction costs than larger, established markets.
- energy savings markets
Energy savings markets, particularly the retrofit market, which targets improvement of the efficiency of an existing building or customer’s electricity use, can take on many forms. One is through utility programs that are legislated to establish very formal methods of engagement between utility and customer. Technologies are made available to customers, incentives are established to assist them in the adoption, and monitoring for verification of savings can help manage some of the risks.
However, efficiency can also be provided through third-party structures that look more like the distributed energy solutions above. Providers of these need to find and engage customers and convince them of the benefits of adopting the solutions. This type of market can be anything from selling the components for cash and having customers install them all the way to a complete outsourcing of the construction and monitoring, paid for on a shared energy savings basis.
- dispatch decisions
The previous section differentiated between short-term markets and long-term markets, and it described many different markets in which existing competitive electricity alternatives compete. Short-term markets represent those that can be served immediately with existing capital in place, and so are limited by the availability of assets and infrastructure to serve them. When power (or savings, or transmission, for example) is needed tomorrow or in the next hour, it can only come through dispatch decisions, or use, of existing stock of capital and is limited by the ability to deliver the services where they are needed in sufficient volumes. For the capital assets to remain in service, they only need to produce income sufficient to cover their marginal costs, and as long as they do they will remain available to compete in the market.
- investment decisions
Over time, however, the existing stock of assets in the electricity system wears down and needs to be replaced. In addition, any marginal growth in energy services demanded requires additional asset investment decisions, or commitment of new capital. But for investors to provide the capital to add new productive assets to the system, they have to be convinced that they will receive a fair rate of return on the capital deployed above their average cost—and that the expected competitiveness of technologies will persist long enough to realize their required rate of return.
The existing installed capital base throughout the entire supply chain is an accumulation of all of the investment decisions people have made in the past, resulting in the current stock of capital available to call upon. Choices made about which assets to add on an annual basis will, over time, alter the mix and operation of the electricity system. In this way, the future of the electricity grid will be determined by the current endowments of capital and any marginal investment decisions. Understanding what drives marginal investment decisions, therefore, is one of the most fundamental tools in understanding the long arc of the electricity system—including its long-term cost, availability, reach, and environmental impact—and everything that depends on it.
Ultimately, investment decisions require the complicity of a number of stakeholders—the developer or operator, various investors, public sector regulators, and the customer. Among these, however, it is the providers of the financial capital, the investors in asset finance, that have the core responsibility of assessing their projects, as they retain a large part of the financial risk of getting that assessment wrong. Understanding how they view these marginal investments is helpful in understanding changing investment patterns and the resulting future electricity architecture that will emerge from those choices.
- value of solar tariff (VOST)
Regulatory models must be actively examined based on root principles, as modest adaptations will be insufficient to deal with the overwhelming tectonic shift in the underlying technology and economic circumstances. The best new regulatory models will encourage technological innovation where it can reduce costs and improve certainty. They will also promote competition and open market access for competitive technologies, as long as that competition helps reduce costs beyond any uncertainty it creates for market participants and their investors.
To succeed, any new regulatory regime must also recognize that markets function best when they receive accurate price signals, and new pricing algorithms are needed to calculate all of the costs and benefits of these new innovations. Utilities should move to real-time pricing models for their own wholesale power market. In the retail market, today’s net metering initiatives need to be enhanced to properly capture all of the potential impacts of distributed energy interventions. Innovations such as the value of solar tariff (VOST) (see Appendix 8 for a description) or the efforts made in New York State under the Reforming the Energy Vision (REV) initiative are just two initial examples of these types of new market and pricing mechanisms.
