Electricity market design is key to tackling climate change

We need to halve emissions by 2030 in order to remain on track to hit 2050 climate goals. According to BNEF, this will require that each year out to 2030, 35 million new EVs, 455 GW of solar, 245 GWh of batteries, and 18 million heat pumps are added to power systems around the world. This will not happen fast enough, or at sufficient scale, if energy markets don't provide the right incentives for businesses and customers. With leading climate scientists predicting that the world will miss its target of limiting warming to 1.5C, it is clear we need to accelerate the deployment of clean energy technologies.

Energy markets that dynamically reflect system costs in a given place, or at a given point in time, are a powerful force for renewable energy adoption. Until now, public policies in many parts of the world have rightly promoted renewable energy buildout and cost reduction through mechanisms such as feed-in-tariffs, net metering and contracts for difference. In places where we are seeing more and more renewable energy come online, the question now is how to keep the power system balanced and flowing so we can reach 100% clean electricity. This requires flexibility: e.g. from factories, from utility scale energy storage, and from fleets of millions of Distributed Energy Resources (DERs) like EVs, home batteries, and heat pumps. To unlock that flexibility, and therefore enable a clean energy future, the right market structures must be in place to incentivize device control for the benefit of customers, the power grid, and the planet.  

At Lunar, we believe that there are three main elements of market design that can enable the change:

1. Market structures should include appealing customer options for dynamic, cost-reflective retail electricity pricing, with appropriate consumer protections in place
2. Distributed energy resources should be able to compete on a level playing field with incumbent utility-scale generation 
3. Customers should be able to actively participate in the energy system and be fairly rewarded for their participation

Creating a virtuous circle

DERs can act in a grid-friendly way: they can enable connection of utility-scale renewables to the grid, soak up excess wind energy overnight or cut demand when supply is scarce. But they also have the potential to be “grid-harmful”: they could all draw power at times of peak demand when supply is already tight. 

The solution is simple: Use pricing to steer DERs into grid-friendly behavior, saving customers money, encouraging adoption, and helping with grid stability. This makes the whole energy system more efficient (and therefore cheaper) in the process. 

When talking about the system being more “efficient” we mean it would need:

• Less overall generation (as we would be shaping demand dynamically to align with wind and solar generation, rather than oversizing supply to meet peak demand).
• Less transmission and distribution infrastructure (as periods of peak congestion on local lines could be managed with DERs, instead of building more capacity on those lines to meet a few weeks of peak need) 

In short, markets that encourage DER participation allow us to get more with less. The energy system benefits would be reflected in reduced average energy prices for all vs. the alternative, as well as in improved economics of owning and operating DERs, creating a virtuous circle of adoption and system efficiency. Of course, some network upgrades and utility-scale generation will be required, but DERs could enable us to only build (and pay for) what we truly need. 

If it's so obvious, why aren’t we doing it?

Regulators are trying, but things are moving slowly (especially given the scale of the climate crisis). Currently a lot of time is being spent on how to remove barriers to DER participation in grid services markets. Grid services are examples of explicit flexibility, where payment is made for capacity or energy at a given time, in separate agreements from normal energy supply. Explicit services make sense when it comes to very short-term frequency services (adjusting supply or demand in a few seconds to keep the system balanced), or long-term capacity markets (essentially, “insurance” to make sure power is available when things get really tight). But overcoming the barriers to involving DERs in the energy market through explicit flexibility has proven challenging. The system is fundamentally designed for a small number of large scale generators which can provide a definite response. 

An alternative is implicit flexibility: where customers have access to electricity rates that reflect grid needs through dynamic prices. When the grid is under stress in a given area, or supply is very short, prices go up. Overnight, when there is a glut of wind energy and low demand, prices can go negative (i.e. people get paid to use electricity). Given grid conditions are constantly changing (e.g. with weather, demand, maintenance, etc.), implicit flexibility requires dynamic pricing over short timescales, e.g. tariffs with different prices for every half hour, every day. Many of the services currently procured as explicit flexibility could be avoided with widespread adoption of implicit flexibility via dynamic pricing.

There are already some offers like this on the market. For instance, in the UK, Octopus offers the Agile tariff, in Belgium Engie and Eneco offer dynamic pricing, and in New Zealand the likes of Powershop and Flick Electric pioneered wholesale-linked pricing for end customers many years ago. These dynamic tariffs require retailers to have billing systems that can handle settlement at these granularities, and are thus very much an exception rather than the norm.¹

Implicit flexibility has the advantage of achieving system-level goals without active control from a central body: customers or DER operators respond to prices automatically. No additional procurement is needed to unlock this flexibility, complex baseline calculations of what would’ve happened without that flexible response aren’t needed, and more value can be retained by the asset owner. On the flip side, such an approach requires high smart-meter penetration, half-hourly (or faster) settlement, and the right technology (controllable devices in homes, and granular billing systems for retailers).

Embarking on the journey

At Lunar, we believe that energy markets should facilitate the seamless flow of dynamic incentives throughout the energy system. We recognize that not all customers will want to be exposed to the complexity and risks of dynamic pricing. We propose that in addition to optional dynamic tariffs, innovative alternatives which allow grid participation without dynamic price exposure are made available. Two examples are “energy-as-a-service” offerings and reduced net energy billing tariffs, but a competitive market will generate more. We’ll dive deeper into these alternative tariffs in our next blog, so stay tuned.

By embracing DER penetration, we can unlock greater efficiency within the energy system, leading to reduced prices for all consumers. As DERs become more incentivized through rate design and market structures, we expect a surge in no-money-down, ongoing subscription offers for these resources, possibly in combination with retail electricity provision. This shift will lift the consumer burden of large capital expenditures, making clean energy solutions more accessible for everyone.

To propel the deployment of clean energy technologies forward and tackle the pressing climate crisis, policymakers and regulators should promote the widespread adoption of dynamic tariffs that reflect system costs. This step is crucial to enable customers and businesses to actively participate in the energy ecosystem and respond to grid needs effectively. Accelerating the rollout of smart meters and implementing half-hourly settlement mechanisms will be instrumental in enabling the seamless integration of dynamic tariffs. Additionally, retailers should be incentivized to support and promote these initiatives, ensuring a smooth and efficient transition to a cleaner and more sustainable energy future.

_{1. In terms of regulation, EU Directive 2019/944 mandates a dynamic tariff introduction in Europe, but has not had a large effect so far. CPUC’s calFUSE initiative proposes the introduction of dynamic pricing in California. In contrast, ERCOT banned wholesale linked retail energy pricing after storm Uri in 2021, and the dynamic PVPC in Spain is proposed to be changed to a longer forward pricing indexed tariff. (It is currently based on day-ahead prices.)}