You're listening to Redefining Energy. Your co hosts from Berlin, Gerard Raid and from London, Lawrence segalem. Today on Redefining Energy, Jard, we took about one of your favorite subject, the power markets. I love prices that go up and down, you know, it just excites me. It's the volatility. Laurent has been so great the last year and a half. It's just been amazing, you know. But first a world from our partner.
It kind of Capital is a sustainable investment and asset development company headquartered in Hamburg in Germany. It could a capital invest in real assets and clean energy and sustainable infrastructure on behalf of its clients. Yes, yeah, it has been amazing for you, but not for regulators and governments who would like to intervene, like to reform the markets. And I think it was probably time for us to do an episode on what are the power markets? Do they need
to be reformed? With other problems? Yeah, I agree with you. It's been a whilcoming this podcast. So when you see the prices we witness, whether it was in the US after the tempest Urine takes us, or of course in Europe the Russian invasion of Ukraine and the consequences on the energy prices. We have had such a creativity from regulators and politicians to change the gap. That incredible inventivity. But are they going to destroy the market by
trying to reform it? What you've said is very important because you talked about the creativity, and actually I think what saved us, Lauran has been the creativity of the market participants, and the market has worked. We've had no brownout blackouts, you just think in terms of gas or the chaos we talked
in around that our energy markets have actually worked. However, obviously there's the market has been very stressed, but I would take a view that this stresses they were coming anyway because the whole intermittent renewables in the system was causing that. So the whole result of all of this is that it's just well, actually, rather than me talk about it, let's go and bring someone in who actually really knows what they're talking about. Right spoiler Alloert for our listeners.
Very geeky episode, Very geeky. Sometimes it's great to be geeky. So we're going to get a real expert on rather than myself from Iron just talking about the markets. We wanted to have someone on that we can have a great conversation and answer. We took Stephen Woodhouse, who really is consultant
globally in and around power market design and what country shouldn't shouldn't do. Stephen is a jorector at a free management consulting Yes, twenty five years of experience in the electricity business and he heads a free global work on the energy market design. Is really the perfect guest to talk about the conundrum of the power markets. Well, let's bring them on. Roun Steve really, thank you very much for coming on the show. Thank you, Gerard, it's a
while since we've spoken. I mean, what we're here to do is to talk about the whole role of the power markets in the electrical system, and also that we'd love to hear your thoughts going forward and just how you see the future of them. You know, people just probably having a clue what the power markets are because most people just go on by electricity and they get it from the local utility. So when they think of power markets, it's
something probably theoretical and far away from them. So maybe you could just start by talking a little bit about what power markets are and what role they have in our energy system. For decades, governments organized power like they organized roads,
and governments were responsible for investment decisions. They had agencies and operators who were responsible for deciding how to use the infrastructure, and like most nationalized industries, on the one hand, it got pretty inefficient because they weren't any good incentives on anybody to do things efficiently. And on the other hand, the government they're not very good at taking long term decisions. They're best at taking
short term decisions. So for a variety of reasons, the kind of consensus in most Western thinking countries was that we needed to bring markets into power rather than do it all through government dictat And we started off in a world most countries liberalized their power markets when they've already got enough infrastructure, so the market's
job is really to use the infrastructure efficiently. And we kind of dabbled in a world where the market gives the incentives to build new infrastructure, at least for power generation. And that worked in a lot of places quite well for quite a long time. But it stopped working well in a lot of places, particularly when the government started taking views on what they thought the right generation mix should be and how green and how renewable and how carbon it should be.
And we've started interfering in the natural kind of investment. And markets are quite good at investing in the same old stuff again and again because it's low risk. Markets are not great at breaking boundaries on investment into completely new areas. So we've moved the scale back towards government intervention on investment and it's changing things quite radically as we moved to a lower carbon system. Stephen, before
we dive in the problem we're seeing now. What you're saying is those markets which have been around for set thirty years have delivered the price signal necessary for an optimizing the generation. So that's the famous merit order, and the second is also delivering price signals for investment. But as I see it, there are different power markets around the world. So we've got continentally your Scandinavia, the UK probably be different front and then in the US with PGMO CASO.
I guess these other means, can you explain a bit what is similar to all those main markets and what is different If you were to categorize power markets, there are probably some dimensions. You would look at one of them is whether the markets are centrally dispatched or whether the dispatch is decentralized, and everything
in the end is a hybrid. But virtually all of the European market designs basically have price incentives, continuous markets through the day, and people dispatch their assets relative to the markets and the market prices, and they take decisions for themselves about how they operate those assets, whereas most of the liberalized American markets, and this is true in Asia and some other places as well, have
central dispatch. In fact, Ireland is a similar model where the generators submit all of their parameters to the market operator and they get told what to do. And that centralized world sounds like a better world if you look at it very simply because you can co optimize a whole load of things. We don't need power stations just to deliver energy. We need them for reserve and frequency
response and inertia and stability and locational congestion management. So if you know all of the operating parameters of the resources, and you know all of the needs of the system, it sounds like a good idea to kind of centralize all of that stuff. But the world is becoming very complicated. The nature of the resources that we're trying to operate flexibly is becoming much more diverse. So
it's not about optimizing power stations anymore. It's about optimizing batteries or EV chargers, or industrial processes, or heating and HP coproduction of heat and electricity. I don't think you can centrally optimize in an office a thousand miles away. I believe that in this new world where we have much more diverse resources, centralization runs out of possibilities and decentralization has to be the way to go.
So this central decentral dilemma is one of the big splits between how power markets are organized. The other big split is whether you say that the energy price is the price and that is the value of energy, or whether you say, well, actually, that's just about the marginal cost and we need to
top up the energy signal with a completely separate capacity product. Now, again, my views are that if you have one energy price, that's a signal to allow you to determine your flows along all of the transmission infrastructure across the whole of Europe. It allows a real time signal for demand response. If you cut a chunk off the top of that value and say okay, well this is now a capacity products. You end up in a much more complicated
world because what do you mean by capacity? Who's eligible? Most of those capacity mechanisms end up being about supply side solutions, not demand side solutions. However hard they try, you end up having to come up with a bunch of arbitrary derating factors to determine how well a battery performs compared to a longer
duration storage asset or a power plant. That's the second big dimension about whether we think kind of investment in firm and flexible capacity should be delivered through the energy price or whether it should be delivered with some kind of separate top up instrument and revenue stream. And I guess you would say there is a third dimension as well, and everywhere is somewhere on a spectrum. Here do you have a price for a huge area or do you have a local price?
And how local is their price? So Europe as a philosophy has zoning, but Germany is a zone all of itself, and until fairly recently Germany and Austria were ones. And although the philosophy is that you have zones that reflect the congestion on the system. Even in the countries with relatively small zones, you don't reflect all of the congestion boundaries. The US markets, many of
which have nodal pricing, but that's still at transmission level. So I think Texas or maybe it's California has something like eleven thousand zones, whereas Europe has somewhere in the region of forty. But distribution networks in the future will be congested. So how far do you want to go with this locational pricing. I don't know anybody who's proposing that you have different prices for each transformer and substation. So in the end, these are all a spectrum. But it's
incredibly hard to do nodal pricing in a decentralized market. So if you want to have locational differentiation, you can probably only go as far as reasonably big zones if you want to retain decentralization. So there are lots of trade offs, lots of trade offs here. So see if just as one market you forgot and I'd love you to talk about and this is the whole sort of
balancing market. In other words, what you have is at some point the grid operator does take over and say hey, listen, we need to make sure a demand and supply balance each other. And that's a completely different market. So could you talk a little bit about that and also just how you see that going forward. There were some politicy decisions in Britain in the old days. If you wanted to connect in a congested area, you got told
to wait. But the government changed its policy about fifteen years ago to say no, no, if winn wants to connect, they must be given a connection and we'll sort out the congestion management later. So the nature of the balancing problem is much more stark these days. There's a lot more variation in the renewables and a lot more ramping for them to deal with within the thirty
minute settlement intervals, and there's a lot more geographical redispatch needed. So the role of balancing is becoming bigger again and the grid operators having to take more and more actions. Now. The logical answer to that as an economist would be, well, let's have smaller time periods and smaller geographical price areas.
If you believe in the philosophy of a decentralized market with a kind of a residual role for balancing for the grid operator, get the market to see the real problem as much as possible, and then let the grid operator have a smaller headache at the very last minute to deal with. I like to talk about pricing because what we've seen in Europe during the Ukraine crisis. Of course,
it's price of gas when berserk and that triggered. First thing is the price last August went to what jar the five hundred open MAGA one hour? No, it went to thirteen hundred euros. So the price went insane. And of course this all the question of marginal pricing inhalation to the last electron fixed the price for pretty much everything. And also we're going to start and entering into moments where there's so much vulnerable as on the grid that in fact
you don't even use gas anymore. So the question is going forward, those markets which will structure around gas, how can they evolve to take into account the fact that you may not have gas anymore into the grids. There are people who say they make a very plausible sounding, but I think illogical and flawed statement. They say, marginal pricing is designed around thermal units which have a marginal cost, and as we increasingly replace the thermal units with units that
don't have a real marginal cost. The philosophy of marginal pricing falls away, and we need to move to some kind of long term pricing that is plausible sounding nonsense. And I think I would say that marginal pricing are paraphrase Winston Churchill. He said democracy is a terrible system. It's just better than all of the other ones. So there are lots and lots of problems with marginal
pricing. So let's start with the philosophy of markets. Markets bring volatility, they bring risk, they bring winners and losers, and because of all of that stuff, people are incentivized to find the most efficient solution. Markets are really really awful and inefficient, aren't they. But do you want somebody else, government determining all of this stuff, because it would be much much worse. So marginal pricing, Gerard, go ahead. Hopefully I triggered a thought.
Just I think it's great to talk about marginal pricing because I agree with you, know, I mean it's not just power markets. I mean basically every market across the world is based in some form of marginal pricing. Where I would love to hear your views is that if I look at the whole amount of sort of variable renewables we have in the system, solar and wind,
we're increasingly having days where we just have negative pricing. So how do I incentivize the build out of that solar or that wind when I know that they're certain days that I'm actually going to have to pay someone to take my power? How do we sort of incentimize from a financial point of view, that generation in the most efficient way. Okay, there are some simple and
some complicated answers here. Negative prices could be good economics if you're thinking about do I close down my nuclear plant overnight and incur a startup tomorrow morning?
Or am I willing to run at a loss for a few hours. So negative prices are not a completely alien concept in power markets, but if they're driven by stupidly written subsidy schemes, then that's a problem with the subsidy scheme, and the right answer would be to kind of renegotiate the terms of those contracts in a way that the generator is still happy, but you don't get them writing negative prices. Having said that, markets are very clever things.
If you have streams of negative prices. We will find people finding clever ways of accommodating how to consume negative priced energy. I was with a tariff in the UK, an agile tariff where actually it was inspimental tariff because I got a smart meter. They basically says your prices double the spot price. They capped it. It was in lockdown at thirty five pencer units and they said your prices double the day ahead spot price. If it's positive, it's positive.
If it's negative, it's negative. And people at the domestic level, we're finding ways of consuming negative price energy. I got an EV charger. I don't have a battery, but some people do. So markets can sort out all kinds of distortions. And if there are systematically periods of negative prices, you'll find people install equipment that can use negative price energy. They won't
be there forever. Can I just follow up that, because I should be asking is how do we incentivize a move away from this all fossil electricity system to a clean energy based system without bankrupting us? Yeah? Okay, So if you build a wind farm, you need to get your money back if you've got a yield of let's say the equivalent of four thousand hours a year. You don't really care if you get paid for four thousand hours a year
and get your money back. If let's say two thousand of those hours the value of the electricity is negative, so really you're only producing on two thousand useful hours. You don't really care if you get paid for four thousand hours a year, or if you get paid more obviously for the two thousand, and you don't produce in the other two thousand. If we are running a system where people are producing electricity when the value of their output is negative,
you are loading a cost onto the system. Now, it might be that we can find ways of soaking up that negative priced energy, but if it's outificially created, we need to write support contracts. And we're looking at this idea of a deem generation CFD that only basically support you to produce when you should be producing, and if the value goes negative, you should damn well stall. So get the support contract structure right. In the first instance.
You should also make sure that renewable generators do face the consequence of their locational decisions. Now in Britain at least, although we don't have locational energy prices we have locational losses and we have locational grid fees, and we charge all the users of the grid for the use of the grids, not just the customers. So the generators pay quite a premium if they want to locate in Scotland where it's congested, and they lose quite a percentage of their output.
I don't know the exact number, but it's three four five percent of their gross production is lost in the transmission losses and that is applied to their CFD revenue as well as their energy production. So make sure you've got the right locational incentives on generators based on where they are. But the losses and the grid costs and the congestion that they cause, that's part of the story. Make sure we're not sticking a load of renewables in places where they shouldn't economically
be. It might be better that they go to places either with a lower yield or kind of more diversity in the timing, so not everybody's producing at the same time, so maybe western east facing solar rather than south facing solar. And you can do that with central planning. You can do it with appropriate tariffs, or you can do it through the support scheme that gives people kind of a locational price that reflects those locational factors. The question still comes
back to marginal costs and marginal pricing. Do we want marginal pricing to determine dispatch And if you think dispatches only of wind and solar in a renewable energy world, what's the point of a marginal price. I think that's a too simple view of the world. We're going to be dispatching storage. We're going to be dispatching electrolyzers, We're going to be dispatching ev chargers. We're going to be dispatching the kind of the cooling systems in data centers which should be
overbuilt with some thermal storage capability in them. This is where our flexibility comes from. You don't think that's going to be done with a spot price. I have no idea what other kind of control mechanism you're intending to use. The Norwegian energy system was built around water. There is no gas in the Norwegian electricity system. They actually built a CCGT and never used it, didn't like it and dismantled it. So the Norwegian electricity system is basically a zero
carbon water fed electricity system. You've got hydro which is run a river, you've got reservoir hydro, and you've got some pump storage, and of course there is some interconnection as well, and that grew in importance. What's the marginal value of water? Well, the marginal value of water is if I store it now and use it later. The marginal value is the value if
I use it later. So you can create an economic marginal cost. If you translated that to a system of wind, sun and batteries, that you could still engineer a marginal cost because it's the opportunity cost, and we would probably have a biomass fueled or a biofuel OCGT fleet at the back end of this system. This is a hypothetical system, and the marginal value is always well, if I haven't got the storage, I'm going to have to fire
up my biofuel OCGT and that's the marginal cost. So because of the possibility of storage, you can create marginal costs even if it looks as if the marginal unit at the time has got zero marginal cost. So Steve that the one thing that you haven't mentioned today is flexibility. And I wonder what your views and this are in other ways. Do we need a flexibility market going forward? Or how do you see it? Yeah, I used to be this is somebody else's phrase, but I used to be part of the energy
only Taliban. I used to believe that we should have an energy only market and that will reveal the value for capacity and the value for flexibility, and people would start trading options that allow you to kind of hedge the value of that flexibility forward. I don't think I can say that stuff with a straight face anymore. We've been so burned by the price spikes. I think the political tolerance of the level of price volatility that that would entail in a high
renewables world isn't credible. But I still firmly believe that supporting just capacity is not credible either. We need lots of different types of capacity. We floated an idea a few years ago of a kind of capacity mechanism that's an adaptation of the US market model. In the US, they have this concept in some markets like New England, of reliability options. So the idea is that the spot energy price can go high, but if you sold a capacity contract,
you have to give some of the money back. So it's a one way CFD maybe a strike price of three hundred dollars. If the spot price goes to four hundred dollars, you pay back the one hundred and I like the idea that capacity is physically an option to deliver energy. But it's no longer just the peak demand that drives the need for capacity. It's the interaction between the renewable generation and the demand. So the duration of those capacity scarcity
periods is changing. We need longer duration storage, and we need capacity, some of which is capable of dealing with kind of within a ramps. For some of it's capable of dealing with very fast changes. So the nature of the capacity need is changing. In the old days, you built a fleet of ccgts and ocgts and they cover all of your capacity needs. For seasonal storage, frequency response, for within a ramping, everything was done with the
same set of technologies. We probably need completely different technologies for all of those different things now. So the short term stability might be done with grid forming converters and synchronous condensers, the kind of within a ramping. Some of it might be batteries, but some of it might be pump storage or some other long duration storage. The kind of seasonal storage. So you get your energy from the sun in the summer and you use it to heat your homes in
the winter. Maybe you do that with aquifers thermal aquifers, you inject heating in the summer and get it out in the winter. So we need mechanisms that reward all of those different time frames for flexibility. I'd like to think they could be set up around option contracts, one way or another. And we come up with an idea a few years ago of decentralized reliability options where
you choose your own flexibility reference market and your own strike price. But I think increasingly we see that capacity support needs government backing, so we probably need to move to some kind of more targeted flexibility support rather than just capacity support. And there's a lot of work needs to be done in this space.
Steve, then maybe just sort of as a last question, just talk a little bit about how you see the whole future of the market, because you know the other possibility courses that we go back to that completely centralized approach that we had fifty years ago, I think we'll end up somewhere in the middle. I don't see governments taking responsibility for making investments and owning assets. And
I also don't see governments wanting the operational responsibility. It's very nice to have an agency to blame if things don't happen as the politicians or as the populace would like. I do not see a kind of a renationalization move, but what we see is increased intervention in the power markets, both operationally in terms of directed investment, but also in cloring back some of the revenues. So we're seeing quite a lot of the European Unions one part of its emergency measures
this idea of effectively a revenue cap. I see a lot more interventionism in the financial and operational aspects of the power markets, and that basically make it an uninvestable without there being government backed contracts, whether it be for renewables, for nuclear or for other types of flexibility. So I don't see government ownership,
but I see government intervention becoming rife in the next decades. So the days of liberalized power markets, which determine investment, those days are gone for the next decade or so. Wow, fascinitying conclusion. I'll probably end up with more questions than answers, but that's how this podcast works. Steven, thank you so much for coming onto the show. Oh it's great having Steve brilliant. Thank you very much for taking the time. I'm very glad you
asked me. Nice to talk to you both. Lan, what's your thoughts, Well, Chard, I'm going to quote the Bible and aligne from the Philippians to twelve. You need to continue to work out your salvation with fear and trembling. And that fear and trembling that's how we should reform the market and not be like politician totally bombastic and wanting to change. Nobody forces the hundreds and thousands of energy trader every morning to open their screen. That's something
natural. That's people optimizing their economics and taking risk or mitigating risk, and market there are an absolute marvel. So I agree totally. And so what I would say, if you're going to change things, you have to change really quickly, because the slower you do the change, the more risk you create for every market participant, and risk means higher price for everybody, and it actually slows down what you're trying to do in the first place, which
is reduced the overall dependence on fossil fuels. So That's the message I would say to about you. It has to be quick, and my fear is it's not going to be quick. Yeah. And the second thing is it has to be baby steps and not big leap into the unknown, because we know what we wish to destroy and we don't know what we're going to get. Now, what I got from this interview is, first of all, people talk about power markets, but in fact they are a very different one
from another. You've got centralized versus decentralized. You've got subsidies or tax for all types of fuels and sometimes not even well coordinated. So in fact, the markets are going to give you prices, but these are gross prices because net prices will have a lot of additional costs. Who's going to add itself to the price of energy. At the end of the day, everything is subsidized and everything is tax and it's hard to know the real price of power.
No, you're right, but what is clear is you need to create an incentive to make sure that the system stays up and that we build renewable assets at a fast level in the coming years. And reflexion after the conversation was what governments and regulators if they really want to change things for the better.
The best thing to do is open up as much as you can to demand side, so otherwise your deregulation to demand side, to allow to demand to respond to what's going on the supply side, to really make sure a price action works. And to enable stuff like storage in the system. You get rid of all the barriers to storage in certain countries you've got grid charges
on it, allow vehicle to griate all this type of stuff. That's the type of thing that is So it's basically for me about enabling flexibility of work. That's what I took out of it. I'm totally with you. And the price signals that the market said are so important because when we saw in April negative prices in continental your hope, or where you see negative prices in Texas, that is the price signal, which is and to market pot sipon
to invest in more batteries. We need those markets and we need them to deliver the price which is as close as possible to the economic reality. Agree totally. And you actually talked about that pricing in the nineteen twentieth of April, where really across continental Europe you had so much renewables in the system, lots of sound, lots of wind, and prices where zero. And this is not on a weekend or any you know, this is not a working
day across Europe. You sort to say, well, what's that going to be like in five years time if you build out lots more meals? You know what re comment from. That's why I go back to making sure that you allow those batteries you just talked about to come into the system effectively and efficiently without delay. Well job, I think it was a great conversation Geki, but we enjoy Geeki sometimes not everypiso, but sometimes. And we thank
Stephen for coming onto the show. Really great performance, and we thank our friends from Aquila Capital to support us. Very good. Thank you very much. Fun I took to you in two weeks time. Look forward to it. Thank you for listening to Redefining Energy. Don't forget to rate the show and subscribe on Apple, Podcast, Spotify or the platform of your choice.