Market design options for electricity markets with high variable renewable generation

Ireland’s climate policy focuses on electrification of heat and transport and decarbonisation of the electricity sector via increases in variable renewable generation (RES-E)[1], such as wind and solar. 70% RES-E is targeted for 2030.

High levels of RES-E present challenges for electricity market design. At present, generation providers earn revenue from energy and capacity markets. Electricity generators sell their electricity in realtime in the energy market. The capacity market remunerates generators for their ability to reliably provide electricity at any hour of the year, whether or not they actually generate electricity.

Renewable generators have limited ability to participate in the capacity market, as their availability is determined by the weather and so they cannot guarantee generation at any hour of the year. RES-E therefore participates almost exclusively in the energy market. This presents several challenges. First, energy market revenues are variable, but RES-E costs are (almost entirely) fixed. Conventional generators, in contrast, have access to both fixed (from the capacity market) and variable (from the energy market) revenue streams. They are therefore better able to match their revenues to their costs. Second, RES-E, when available, displaces generation from fossil fuels, lowering the price of electricity during those time periods. The electricity price is consequently lower, on average, during those hours that RES-E can earn electricity market revenue compared to hours when RES-E is not available to generate. This is known as the price cannibalisation effect, and reduces RES-E revenue.

[1] RES-E refers to “Renewable Energy Sources: Electricity”.