Wholesale electricity markets, which serve two-thirds of the United States, are at an evolutionary point as fading economics push coal and nuclear offline while state-level clean energy targets and fast-falling renewable energy prices push clean energy onto the grid.

But these seven U.S. wholesale electricity markets were designed around fossil fuels, and without reforms, they will become increasingly ill equipped to handle the influx of renewable energy and flexible distributed energy resources (like battery storage) coming online.

Grid managers and policymakers are considering how U.S. wholesale electricity markets should be restructured as they rapidly decarbonize, and shift to an energy system becoming dominated by carbon-free resources with near-zero power production costs.

A new research paper series seeks to answer the question raised when clean energy becomes the cheapest option for a grid designed around fossil fuels: What wholesale market design can reliably integrate clean energy resources and decarbonize the grid at the lowest cost?

A rapidly changing grid

Current wholesale electricity market rules and practices were established to manage yesterday’s power system: large central coal, nuclear, and natural gas plants generating electricity to meet inflexible demand. Markets were originally designed to incorporate some demand-side flexibility in addition to their primary function of managing supply-side generation.

Yet regulatory, economic, and technological barriers have largely precluded demand resources like batteries and smart thermostats from participating in wholesale electricity markets.

With limited participation from demand resources, the wholesale market has functioned primarily with grid operators dispatching large central station plants to meet unalterable demand. But today’s power system is quite different.

Renewable energy is now cheaper than coal and nuclear, and is cost competitive with natural gas, in most parts of the U.S. The country’s wholesale electricity markets are changing accordingly as wind, solar, and energy storage replace fuel-burning power plants—and this trend is certain to continue due to state policy.

Twenty-nine states plus Washington, D.C. currently have binding renewable energy targets, eight states plus D.C. have enacted 100% clean or renewable energy goals since 2017, and legislation introduced in the U.S. Senate would set a 50% by 2035 renewable energy standard.

This rapid grid decarbonization electricity market rules, products, and software developed for 20th century technologies are increasingly ill equipped to handle the 21st century technologies rapidly coming online.

The newer resources differ in several important ways from the fuel-burning electricity resources of the past:

These resources typically have near-zero production costs. Their costs are almost entirely paid up front, and they are very cheap to run once built. Because electricity market dispatch and prices are tied to production costs, this trait is a significant deviation from fuel-reliant power plants. Newer resources tend to have smaller minimum unit sizes—on the order of tens of megawatts rather than tens of gigawatts. That means these resources can be deployed more quickly and in smaller unit sizes. The different production characteristics of these newer resources are changing how the grid is managed. For example, solar output predictably follows the sun rising and setting. Planning and running the grid around resource availability is not a new concept for grid operators, but doing this daily for a large set of resources is pushing operators to consider new market rules and products alongside newer resources that can provide better or cheaper grid services than fossil fuel resources. Technological barriers that limited customer-side flexibility are rapidly disappearing. Smart thermostats, water heaters, and the “internet of things” can turn electricity demand into a grid resource to soak up large amounts of variable renewables.

Markets in need of reform

Serious technological changes are hitting the grid, but the concomitant changes in market incentives and rules are lagging behind. Wholesale electricity markets must evolve to support decarbonized energy systems, but how they will evolve is an open debate.

Energy Innovation’s new research paper series “Wholesale Electricity Market Design for Rapid Decarbonization” proposes two pathways for how the system could evolve over time.

The “Robust Spot Market” pathway focuses on improving the short-term markets for energy and services already present in all of today’s markets, and replacing markets that pay generators for their capacity (i.e., capacity markets) with widely used voluntary contracts for energy and services.

The “Long-Term Plus Short-Term Markets” pathway envisions complementing those improved short-term energy and services markets with a sophisticated, centrally administered long-term market to deliver needed resources and services.

Both pathways agree on several important market features:

Competitive wholesale electricity markets are a good thing: A larger portfolio of diverse resources improves reliability and decreases costs—and the larger the market, the greater the benefits.

Wholesale electricity markets need to work with external (state or federal) policies governing the electricity system, not work against(i.e., mitigate) them.

Current capacity markets in operation around the U.S., which largely trade capacity without much regard for how the energy resources operate, should be fundamentally transformed or eliminated.

Shorter dispatch intervals and multi-period optimization can make markets more efficient.

But the two pathways disagree on important market features, driven by different views on questions like:

How big of a risk is political interference in markets?

How much will the “real world” behave as theory suggests?

What is the risk that real-world prices—often driven by uneven fossil fuel retirements—will be too low for utilities or other load-serving entities to buy flexible and well-hedged smart energy resources to serve customers over the long term?

Is keeping voluntary contracts for energy the best approach, or would a centralized administrator for those contracts be more beneficial?

Questions for the future

Several questions will be central to whether wholesale electricity markets can support the wide-scale deployment of low-cost, low-carbon resources required to meet ambitious policy targets and cut emissions fast enough to help prevent dangerous climate change.

For instance, how can markets efficiently price generation in a system with large quantities of energy resources with near-zero production cost? How can markets maintain sufficient investment signals, and how can new types of resources be financed as markets evolve? How will grid infrastructure like transmission lines and energy storage be financed and built? How will cap-and-trade or carbon pricing influence wholesale electricity markets?

These are tough questions without a single “right” answer. Reasonable people can, and do, arrive at different answers—but the time to consider them is now. The Senate Energy and Natural Resources Committee and House Select Committee on the Climate Crisis have held hearings on the future of U.S. electricity markets, and several proposals before the Federal Energy Regulatory Commission could influence future market designs.

Wholesale electricity markets will evolve differently in various regions, but grid managers must deliberately consider these issues as the electricity system decarbonizes.

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