On 2 August, the German Federal Ministry for Economic Affairs and Climate Action (BMWK) published an options paper titled “Electricity market design of the future – Options for a secure, affordable and sustainable electricity system”. The publication was long-awaited and met with high expectations.
The paper explains four central fields of action and in some cases already makes suggestions for their implementation:
- An investment framework for renewable energies
- An investment framework for controllable capacities
- Local signals
- Leveraging demand-side flexibility
As a company that advises industrial companies, municipal utilities and investors in large-scale battery storage systems on flexibility issues and distributes this flexibility on all short-term markets, we are primarily driven by the question of how our electricity system and, with a view to sector coupling, our entire energy system can be used more efficiently by means of new technologies and behavioural changes in system operation. There is a consensus that the physical infrastructure, i.e. the grid, needs to be expanded. However, there is also a growing consensus that this should not be done “for the last kW of peak power” – whether on the generation or demand side. The solution lies in the more efficient use of resources described above. The key to this is flexibility. We counted up: the term “flexibility” was used 144 times in the BMWK paper and described as a cross-sectional task across all areas, in some cases with complex reciprocal effects on the other fields of action.
In the following, we will therefore focus on the two relevant fields of action “controllable capacities” and “demand-side flexibility” and attempt to classify the proposals with a practical perspective.
Alternative technologies must be considered in the implementation of the capacity mechanism
Controllable capacities, as a complement to volatile renewable electricity generation from wind and solar power, should guarantee security of supply for just a few hours a year. This paper transforms the previous “whether” into a “how”. It is no longer a question of whether we should introduce a capacity mechanism in Germany, but how it can be realised. Various options are mentioned:
- Capacity hedging mechanism through peak price hedging
- Centralised capacity market
- Decentralised capacity market
- Hybrid capacity market with a combination of centralised and decentralised elements
All these approaches have different advantages and disadvantages. We want to evaluate them primarily based on how suitable the different options appear to us for the involvement of alternative technologies such as demand-side flexibility or large-scale battery storage.
Design options and challenges of a capacity mechanism in Germany
In the centralised capacity market, a central authority is responsible for the design and sizing. It sets the rules of the game (the conditions for participation) and continuously defines how much controllable capacity is required. This makes it a fairly simple option that can be implemented relatively unbureaucratically. However, the weaknesses and challenges become apparent during practical implementation, especially with regard to the alternative technologies mentioned above. The conditions for participation, in the form of specific so-called pre-qualification conditions, must be formulated in such a way that the required and necessary openness to technology is also guaranteed in practice. Specific technical, operational and commercial criteria must be defined to enable or exclude participation. It is a real challenge to specify these conditions in such a way that all eligible options – for example, gas or hydrogen power plants as well as alternative capacities such as industrial loads or battery storage – can participate as equals. However, to be able to use as many plant classes as possible and thus the most cost-effective capacities, there must be real equality of opportunity. Our own experience with existing capacity instruments, such as the capacity reserve, and examples from other countries show that this point is absolutely critical and must be carefully designed in every detail.
In the decentralised capacity market, the responsibility for a secure supply of electricity is transferred to the suppliers or, in the case of energy-intensive industry, to the consumers themselves. The decentralised model offers different options for how capacities can be provided. Suppliers can decide whether they (1) incentivise their customers to reduce their consumption in times of low wind and PV production, (2) invest in maintaining their own capacities or (3) acquire so-called capacity certificates to secure their supplies. What the three options have in common is that they draw on a very broad market knowledge of all experts (and innovators) and are much more competitive in their approach. The form of capacity certificates in particular may be more suitable for the participation of alternative technologies. The biggest disadvantage of a decentralised capacity market is that its liquidity horizon does not ideally match the investment horizons of large-scale investments in power plants. This is also one of the obvious reasons why the BMWK currently favors a hybrid approach.
The hybrid approach combines centralised and decentralised capacity market elements with the aim of bringing together the best of both worlds. The centralised component is intended to secure large long-term investments. The decentralised component is intended to promote innovation and integrate future developments that are not yet foreseeable with a central planning approach.
The decisive question will be whether and how well this model can be put into practice.
- What will happen if the outcome of the decentralised part of the capacity market is not as expected? How long will it be possible to persist – especially with regard to the investment and planning security of alternative technologies and the business models developing behind them? Or will there be a shift in capacities towards the centralised component, so that in the end there will effectively be a centralised capacity market after all?
- How well can such an unprecedented construct be implemented? Will a hybrid capacity market develop into a bureaucratic monster or is it possible to find a form of organisation that is practicable and therefore also accepted?
- Is implementation feasible within the required timeframe – also with regard to authorisations within the framework of European law?
If these questions can be answered and addressed satisfactorily, a hybrid capacity market may well be a challenging but innovative way of combining pragmatism, risk reduction and long-term planning security (centralised component) with innovation and market economy (decentralised component).
The need for flexible behavior is already immense today – existing barriers must be removed and further incentives created
The paradigm shift that flexibility will play a central role in our future energy system is not initially spectacular news. What is new, however:
- The need to make much greater use of both demand-side flexibility and – in the case of behind-the-meter self-generation systems – generator-side flexibility is becoming increasingly apparent.
- There is an increasing effort and determination to remove existing barriers and create the right incentives for flexible behavior.
We already have many periods in which renewables produce so much electricity that we literally do not know what to do with it. In 2024, we have already seen as many hours with negative day-ahead prices on 29 July as in the whole of 2023. The prices for the provision of control reserve are very high, especially along the PV generation, because there are hardly any controllable generators available for full 4‑hour time slices during these times and, to be available – i.e. in operation – their opportunity costs are so high that they require the correspondingly high compensation for the provision of control reserve. From the perspective of the distribution grid operators, to whom the vast majority of renewable energy plants are connected, the problem is even greater. To date, they have significantly fewer dedicated and established instruments than the transmission system operators with redispatch and control reserve.
In the future energy system, especially in view of the major plans to expand renewable energy, the only possible response is therefore to promote flexible behaviour at all grid levels. This includes removing existing barriers as well as setting the right incentives – for instance, in the form of appropriate grid fees.
Reform of industrial network charges: Necessary open-heart surgery
One of the biggest, if not the biggest challenge in this context is the reform of the individual grid fee regulation for energy-intensive industrial consumers. The current regulation incentivises two different types of behaviour: (1) load reduction during predefined peak load time windows to counteract the peak load in the upstream grid; (2) constant consumption behaviour to optimally utilise base load power plants. For both types, there were good reasons to promote the respective off-take behavior. However, with the transition of the generation mix towards an increasing share of volatile renewable generation, these parameters are gradually shifting, so that the basis for the described behaviors is changing significantly (peak load time window) or disappearing completely in some places (base load consumption).
In theory, the matter is therefore quickly described. In practice, however, the situation is not quite so simple. Many companies in the basic materials industry (e.g. paper, chemicals, metal, glass) have optimised their processes over decades for precisely the operating mode described above. Be it the plant operation itself, but also the upstream and downstream process steps.
For example, in the material network or in the storage of raw materials, semi-finished and finished products. Some processes cannot even be made substantially more flexible — at least not today.
This is where the whole dilemma becomes apparent. But what is the conclusion to be drawn from this? Do nothing at all? Not an option! For several reasons:
- In any case, the derogation will not be sustainable under European law and will therefore end at some point.
- Just because not everyone can be flexible does not mean that we can do without those who can be with a view to our future energy system.
Parallel to the “big debate” on the future design of the electricity market, the Federal Network Agency has begun consulting on a reform of the current grid fee regulations for energy-intensive industry. Against the backdrop of the tensions described above, it will be important to remove barriers to flexibility and promote those who can be flexible. This can result in a competitive advantage for the relevant companies if, for example, they can purchase cheap and sustainable renewable electricity, as well as economic value if the relevant companies react to high price signals and shift parts of their production, for example. At the same time, however, it must also be recognised that there are sectors and companies whose demand for electricity cannot be made more flexible, or not flexible enough. It must be ensured for these companies — and this is presumably not a task for the regulatory authority — that they continue to have a competitive basis in our country and do not (have to) migrate. Energy-intensive industries, particularly in the basic materials sectors, are at the beginning of industrial value chains and often form entire production clusters with their downstream customers, which must not be jeopardised lightly.
Combining ambitious goals & real risks to strengthen Germany as a location for innovation and industry
As a technological nation and a society that is more dependent on innovation than almost any other industrialised nation, we must strive to break new and ambitious ground. The restructuring of our energy system, in which we combine new, sustainable generation technologies with new, digital technologies, is precisely this path. At the same time, however, we must also keep an eye on the risks and the economic and political realities and must not jeopardise the short-term competitiveness of our industrial foundation.
BMWK & BNetzA publications on the topic:
