Designing an energy market with DSR18 February 2016
Demand side response (DSR) will be a key feature of the European electricity supply system in its attempt to achieve the EU’s ambitious energy policy objectives. A new ENTSO-E policy paper provides an overview of market design options for successful DSR integration.
The recently published ENTSO-E policy paper Market design for demand side response provides an overview of market design options for DSR integration in day-ahead, intra-day and balancing energy markets. DSR will also have a major role to play in capacity markets, provided it meets reliability requirements. ENTSO-E is the organisation of European TSOs.
The European Commission has stated that any review of the market design must create conditions that allow for the cost- effective integration of new types of flexible demand into the market. In its 2014 policy paper, ENTSO-E, in line with this statement, advocated the further development of DSR and highlighted the associated benefits, from the reduction of energy costs for consumers to making the system more flexible and increasing competition in the markets.
Therefore it is important, says ENTSO-E, to ensure the development of a market model that values demand flexibility. This will allow the potential of DSR to be released while preserving adequate incentives (especially balancing incentives) among all market players. At the core of this challenge lies the fundamental requirement to define an appropriate market design by setting roles and responsibilities and configuring all market mechanisms in a way that improves the participation of the demand side.
For an efficient representation of the demand side, consumers should be able to better react to market prices. This implies that all relevant markets are opened further to competition between DSR and other resources on fair and transparent terms.
DSR integration in energy markets
The complexity of DSR integration in energy markets must not be underestimated. Any evolution must preserve the well- functioning of markets and their design components, such as the pivotal role of balance responsible parties (BRPs) their information needs and balancing incentives. For a TSO, the choice of market model comes from a trade-off between the necessity to preserve residual system balance while facilitating the development of additional resources.
DSR participation in reserves capacity markets can represent in some countries a large part of DSR's economic potential provided it features a high level of reliability, including data management and security requirements. This additional potential for reserves will be crucial for TSOs in countries with increasing levels of variable renewables, and can confer a key co-ordination role on all DSR products in the market design. Figure 1 illustrates effects in the Danish market.
At the present time there are technical, financial and organisational challenges for end consumers' participation in markets, although the technical challenges are no longer the main limiting factor for DSR development. The economic potential for DSR can be revealed with a market design that exploits its technical potential, taking into consideration associated costs and added value.
Further opening of day-ahead, intraday and balancing energy markets, as well as reserve capacity markets, is necessary to fully enable participation of all DSR players.
Market price formation
One of the main challenges for the European electricity system is the lack of effectiveness of price signals to stimulate appropriate investment and performances.
Accurate short-term market price formation is necessary to reveal the value of flexibility in general and of DSR specifically. Proper energy price formation in the day-ahead, intraday and balancing energy markets requires not only that DSR activations are based on price signals, but also that the price signal reflects DSR activations. DSR participation in reserve capacity markets will increase competition and improve reserve capacity price formation.
Distortions can also exist outside the electricity sector and impact the retail level, for instance, with other competing commodities such as gas or heat. Crossmarket consistency between commodities that can be substituted for one another (eg, electricity and heat) is necessary to enable efficient use of DSR in the electricity market, and particular attention should be paid to differences in taxation, grid tariffs and regulation.
Consumer prices that reflect cost
Efficient DSR is based on the consumer's making an economic choice between the value of consumption on the one hand
and the value of non-consumption or postponement of consumption on the other.
The former is the value the consumer gains from energy use, while the value of non-consumption is the market value of the associated products (commodity, imbalance) or the cost of alternative energy sources (e g, gas, biomass, storage).
In certain countries, however, for most customers (especially households and small and medium-sized enterprises), the variability of such market value is not perceived because electricity supply contracts are stipulated with fixed prices that limit consumer choice to changing suppliers.
A possible approach to improving that choice is to expose the consumer to prices reflective of the energy cost at the time of consumption and to react to changing electricity prices. This, however, requires appropriate price incentives. While this is already the case in several retail markets - because consumers can sign supply contracts using, for example, hourly day- ahead price references - in other markets the level of consumers' price exposure is limited by the relatively low proportion of the energy component in the final electricity cost (including taxes, levies and grid tariffs).
The role of metering
Another possibility for the consumer is to sell its flexibility on the market, either directly or via a third party such as an independent aggregator. Such an approach normally requires a baseline methodology to determine and control the amount of energy or power delivered.
Efficient price exposure requires accurate allocation of energy based on actual and suitably accurate metering, which is a key enabler for DSR and must be used as a reference wherever available. If meters are not available or sufficiently accurate for specific DSR products, appropriate regulation can enable alternative metering solutions. For instance, TSOs can decide to certify the metering process of DSR providers of balancing services and use their data for balancing products.
Acting on price data
In some markets, access to price information and the physical action to trigger DSR can incur significant transaction costs for the consumer, especially for small consumers and complex products. Open access to market prices, full transparency on price formation and market rules both at retail and wholesale levels are necessary. Consumer involvement, however, requires that for small consumers, price signals remain understandable and manageable.
Consumption awareness is necessary to identify DSR potential, which can be difficult not only for households but also for industrial consumers since it requires dedicated expertise, a core business activity for companies developing DSR.
Activation of DSR can be carried out by the consumer itself, either manually or through predefined procedures, or by a third party such as the supplier. It can also be automated, which significantly reduces transactions costs for consumers. Standardisation of interfaces between technologies can also reduce transaction costs while avoiding the slowing down effect on innovation.
A suitable DSR framework
DSR implies that all consumers can participate in all relevant markets either directly via suppliers or through an aggregator, but many markets have barriers to entry for DSR players.
In some, processes and regulatory frameworks were set up when the potential for DSR was considered limited, while in countries where a specific DSR market design is being implemented, regulatory instability can negatively affect implementation efforts.
Market access for DSR is not sufficient in itself because all interactions with other stakeholders must be carefully considered and managed, in particular with BRPs, which are financially responsible for balancing their own positions, and by doing so, contribute to the balance of the system. Changes such as the growing share of renewables increase the complexity of and risks to the BRPs so it is essential that BRPs are correctly informed to be able to fulfil their role, and enjoy appropriate balancing incentives and means
to carry out their functon.
Market participation of DSR can be facilitated by certain features of products and markets (eg bid size, bid time and/ or gate closure time). On the other hand, aggregators or large consumers themselves have a core competence in transforming the underlying complexity of DSR resources into generic products. The right balance must be found when adapting balancing products to DSR to avoid an unintended delegation of the aggregation business to TSOs.
The business case
The willingness of demand side actors to participate depends on a good business case, therefore the economic efficiency of DSR should be the primary driver for its development. Other aspects that can increase consumers' willingness are the ability of DSR activations to be performed smoothly and not impact normal business activities, and possibilities conferred by the positive image of DSR.
Economic viability of DSR also involves competition issues. If consumers want to offer DSR through an independent aggregator, the resulting unbundling between supply and flexibility creates value by opening an alternative growth path for DSR on the offer side of the market. Hence, consumers themselves optimise the economic value of DSR when pursuing their own commercial interest, through negotiating the flexibility clauses of their supply contract or a dedicated flexibility contract with an independent aggregator.
Sufficient competition among energy suppliers on one side and independent aggregators on the other is key in providing consumers with the negotiating power to optimise the economic value of flexibility.
For DSR to benefit society as a whole, the potential introduction of subsidies must remain limited to what would strictly be necessary to achieve policy objectives and kick-start DSR development. There should be a clear and clean separation between economic subsidies and market design, avoiding hidden biases that unseat fair competition.
Communication and control
Emerging technologies and automation are important tools for DSR participation. TSOs and DSOs need to support and implement solutions that Include communication and control technologies enabling DSR for small consumers, such as multiple use of advanced metering technology and steering components for boiler reserve control.
IT and technology are constantly developing, so when developing solutions for demand-side response it is important to anticipate future technological evolution. The most optimal solution in the current technology framework is not necessarily the most optimal solution in the future. And information flow among parties must ensure that information access supports competition and good market practice and meets market parties' need of clarity.
Models for market integration
To facilitate the participation of DSR, different models exist or are being implemented. Table 1 outlines the options and how they are classified. From a market design perspective, an integrated approach for supply and DSR is the simplest route and avoids interfering with other stakeholders. However, it does not allow aggregators to operate independently from suppliers, which may prevent unlocking the full DSR potential in some markets. Complementing this model with other solutions should therefore be considered.
The economic efficiency of the variable supply price model, compared to the supplier load control model, is reduced if there is a significant gap between energy retail and market prices.
The bilateral agreement model allows independent aggregators to operate with a low degree of complexity, and ensures fairness for impacted stakeholders because of the implied consent in the agreement. The economic efficiency of this model depends on the conditions set out in contracts.
Market designs without bilateral agreement ensure pre-contracting confidentiality and allow independent aggregators to act without consent from suppliers. In addition, some of these models make post-contracting confidentiality of DSR activations possible, which further reinforces competition between suppliers and independent aggregators.
Economic efficiency is ensured if the price to settle the transfer of energy with suppliers is cost-reflective. However, such solutions require evolutions of the market design, which will take time to develop.
DSR can be integrated in capacity reserve markets. Capacity products can produce valuable guaranteed availability, can be traded between parties in reserve capacity, and can be used to balance the system.
Further market integration of demand-side response is crucial to enabling its efficient use and economic viability. Development of DSR should ensure that demand elasticity is adequately reflected in short-term price building and long-term investment incentives.
DSR can deliver different types of particiption, but this is not straightforward and raises several challenges. These challenges can be overcome with concrete market design solutions that already exist and are being implemented or experimented with in Europe. Most of these solutions are not mutually exclusive and can be considered as complementary approaches for gradual implementation to unlock more DSR potential.
Implementation choices, that is, of market model, should be driven by cost-benefit analyses accounting for local context elements and conditions such as economic efficiency, competition, fairness, complexity, robustness and the potential to unlock additional flexibility.
Particularly important are considerations about competition among all DSR market actors and potential barriers to new entrants, since these will influence the regulatory choice of whether DSR should be operated only directly, via suppliers, or via third parties such as independent aggregators.
A market model safeguarding commercial post-contracting confidentiality for aggregators might facilitate further the development of independent aggregators but might also have a negative impact on the balancing quality of BRPs owing to a lack of the kind of information required for balancing and forecasting.
Author: Staff Report
(Originally published in MPS January 2016)