“Peak Shaving Products” and “Flexibility Support Schemes” aren’t Electricity Markets

Electricity market reform

“Peak Shaving Products” and “Flexibility Support Schemes” aren’t Electricity Markets

Later today, the European Commission will launch its legislative proposal on how to reform electricity markets.

While contracts for differences and power purchasing agreements get most air time in the reform debate, many more changes will likely be announced. Among them: the idea to define a novel “peak shaving product” that transmission system operators ought to procure, and new “flexibility support schemes” that members states may implement to pamper demand-side response and energy storage.

I believe these proposals are fundamentally flawed. They aren’t flawed in implementation details, but the whole line of thinking goes in the wrong direction. Here is why:

Markets attach value to things that people want or need. European electricity markets comprise a range of segments and compartments that do exactly that: pricing various services that consumers or system operators require. This is particularly true for spot markets, intraday markets, and the imbalance settlement mechanism, where megawatt-hours of energy are traded between producers and consumers. It is also true for procurement auctions for ancillary services such as balancing reserves, where system operators buy specific services that they require to run power grids.

The price signals that emerge from these markets reflect the value of the respective “electricity good”. Power tends to be more expensive at times of high demand and low supply. It also tends to be more expensive when demand occurs on such short notice that only few, expensive generators are quick enough to serve the need. Balancing service providers do not only receive a payment for the delivery of energy, but also for standing by to do so on short notice – because the readiness itself is a service that is in demand.

Against the backdrop of a well-developed, granular short-term electricity market, defining, procuring or subsidizing specific “flexibility products” seems an odd idea. Take “peak shaving” first: during cold winter nights, when high demand meets scarce supply, spot prices often reach high levels. It is exactly these high prices that incentivize consumers to cut or postpone consumption. In addition, consumers who are willing to reduce consumption on short notice can (and do) sell this ability on downward balancing markets.

The incentives for peak shaving (and all other forms of demand response) are already there! They are baked into the array of electricity markets that we have. It is neither necessary nor helpful to separate out demand response into a new artificial market segment. Procuring a dedicated “peak shaving product” is useless at best and will divert resources from existing markets at worst.

For “flexibility support schemes” the matter is even worse. Where “peak shaving” can at least be reasonably well defined, flexibility cannot. Flexibility is an umbrella term for all kind of properties and phenomena, but nothing that is clearly defined. It is used to refer to resources that are firmly available, that can deliver energy very quickly, or are located at the right place within the grid to be useful for congestion management. It is quite hopeless to define a flexibility target and pay out subsidies “per MW of flexibility”. Is a MW of gas-fired generation capacity, a MW of home batteries, and a MW of flexible electrolysis equivalent? Certainly not.

Don’t get me wrong: I am a big fan of demand-side flexibility and batteries. We need more of that stuff, for sure. But these resources are not good in themselves, they are only there to provide a service. It is the provision of that service that should be remunerated – by selling energy and capacity to spot, intraday and balancing markets.

In EU jargon, responding to electricity prices is sometimes referred to as “implicit” flexibility. Maybe we should it better call “real” flexibility. Or simply: flexibility. In fact, the best definition of flexible resources might be “producers, consumers and storage operators that respond to short-term price signals”.

Dedicated flexibility products such as demand response programs or flexibility subsidies may make sense if exclusively targeted at those actors that are not exposed at spot prices and cannot participate in system services markets, such as fixed-price retail consumers. But the better approach would be to actually enable them to participate in these markets, through dynamic pricing, aggregators and device-specific submetering. Better tear down barriers to actual markets rather inventing substitute markets.

Let us make sure that day-ahead auctions, intraday markets, imbalance settlement prices, ancillary service auctions, and granular grid fees provide proper price signals to electricity consumers and producers, big and small. Then there is no need to invent novel market segments or define flexibility producers.