Grid makeover: New research shows how the integration of renewables is exposing design flaws in energy markets and offers paths to improvement

This post is the third in a series dedicated to the future of the electricity sector and new scholarship supported by the Alfred P. Sloan Foundation. Each post is based on a discussion between select researchers and experts working on relevant policy. To learn more and join one of our upcoming conversations, visit the series website.

As energy providers around the country integrate a growing volume of wind, solar and batteries into their systems, researchers and regulators are seeing compelling evidence that markets may require design adjustments to address inefficiencies.

Our recent webinar, funded by the Alfred P. Sloan Foundation, examined how market designs can lead to clean energy outcomes—and potential unintended consequences like an increase in CO2 emissions.

Moderated by Sarah Ladin, an attorney at the Institute for Policy Integrity, the panel—which you can watch here—included Dr. Catherine Hausman, an associate Professor of Public Policy at the University of Michigan and a research associate at the National Bureau of Economics Research, Dr. Chiara Lo Prete, an Associate Professor of Energy Economics at the Pennsylvania State University and Valerie Teeter, the Deputy Director of the Office of Energy Market Regulation at the Federal Energy Regulatory Commission (FERC).

Ancillary services markets, renewables and their impact on generation

While most economists tend to examine wholesale energy markets, Dr. Hausman has researched ancillary service markets, which provide essential services for maintaining a secure and stable power system. One of these markets is the frequency regulation market, which is crucial for ensuring reliability. This market helps maintain the appropriate balance of supply and demand by paying generators to make small adjustments to their output. Dr. Hausman’s research explores the potential for ancillary service markets to interact with and affect the wholesale energy market.

Her research studied the PJM frequency regulation market in the northeastern United States from 2012-2014 to show how generators responded in the wholesale energy market. Her team discovered significant spillovers across markets, as generators adjusted both the amount of energy they generate as well as the fuel and technology type. For example, because the frequency regulation market requires generators to fluctuate their generation, some may need to increase their daily generation significantly in order to allow for the footroom needed to make these adjustments. These results suggest that the ancillary services markets interact directly with generation markets in ways that academic economists haven’t previously considered.

Renewables, batteries and climate change are leading to a rethinking of ancillary services, she argues. If system operators aren’t careful, the utilization of batteries to provide frequency regulation could lead to the unintended consequences of increasing CO2 emissions. For example, if a battery enters the frequency regulation market, this may reduce the need for a coal plant to participate in frequency regulation, resulting in an increase in coal-fired capacity in the wholesale market and, in turn, emissions. “In a world without the ideal carbon emissions regulation that we might hope for,” Dr. Hausman argued, “we need to be careful about the unintended consequences of our policies, especially around things like new technologies or changes to electricity markets.”

Managing the unpredictability of wind

Dr. Lo Prete’s research examined why the increasing penetration of wind in U.S. energy markets poses a unique challenge. Markets operated by Independent System Operators (ISOs) rely upon forecasts to schedule dispatch of both wind and non-wind resources one day ahead of time (with adjustments to dispatch happening in real time as demand and supply varies). While weather forecasts have improved dramatically, predictions for wind are not as precise, and any inaccuracy can impact other forms of energy, which need time to adjust their generation (for example, coal plants take 10-20 hours to reach 70% capacity).

If the wind does not blow as expected, “peaker” plants (dirty, inefficient fossil fuel-based generators that run only a few hours of the year) must ramp up quickly to meet demand. Conversely, if the wind blows unexpectedly hard, some non-wind generation units that had ramped up the day before in response to the forecast lose their spots in real time, leading them to burn fuel while sitting idle (units that have committed to turning on can’t easily turn back off, and then run at their minimum output level). “Once they’re committed, they can’t be de-committed,” Dr. Lo Prete explains.

Both these outcomes are inefficient and can increase the need for uplift payments, or out-of-market payments to generation or demand response resources that ensure generators are adequately compensated when they’re ordered to either produce or reduce power. Ensuring that forecasts are more accurate is one way in which these inefficiencies can be reduced.

She also found an interesting interaction between the wholesale and ancillary service markets that creates greater inefficiencies due to wind variability and inaccurate forecasting. Specifically, for baseload plants (including coal and natural gas combined cycle) that participate in both the energy and reserve markets, if the wind ends up blowing less than expected, these plants can shift capacity towards generating, thereby reducing their reserves. Because these plants are cheaper to operate than peaker plants, this reduces the market clearing bid below peaker plant marginal costs, thereby requiring more uplift. Dr. Lo Prete was surprised by this finding, and said she originally had not planned to incorporate both markets into her research. But her findings demonstrate the need for researchers to think about the system in a holistic manner, incorporating all market participation into their modeling efforts. She encouraged researchers in the audience to take this approach, stating that “it’s going to become more and more important to look at the combination of ancillary services with energy markets, and with other markets as well (such as capacity markets).”

FERC exploring market reform

Ms. Teeter noted that as the resource mix is changing, FERC (the agency that regulates transmission and wholesale markets) is exploring how market design in both the wholesale and ancillary service markets can address the need for greater operational flexibility. Given variable energy resources’ inability to ramp up or down generation on demand, the remaining generation needed to meet total load will need to be much more flexible in real time.

It is therefore critical that market rules do not create participation barriers for generators that can quickly ramp up or down. The Commission is exploring whether new market products can help compensate those generators able to meet this ramping need, as well as how market designs can better incentivize resources to reflect their operational flexibility in their price bids. Given that new resource types such as batteries have greater operational flexibility, the Commission is also examining whether market rules create any undue barriers that prevent these resources from providing this much-needed service.

Need for continued interaction between academics and policymakers

During a robust discussion among panelists, Dr. Hausman noted the critically important link between researchers and regulators. Because the grid is changing so quickly in the absence of a national climate policy on carbon emissions in electricity markets, researchers should be looking into unintended consequences and presenting their findings to agencies like FERC to find adequate solutions. “The market is not just going to automatically take care of itself,” she said.

Regulators rely upon this type of input for making informed decisions. Ms. Teeter described some recent technical conferences during which stakeholders, experts and academics discussed key issues related to changing system needs. Conferences like these, as well as the public docket, she noted, are ideal venues for academics to share some of their latest thinking on market issues and challenges that may exist.

“Commission staff appreciates the ability to dive into these issues and understand the technical thinking that’s been done and have that thinking inform their decisions,” Ms. Teeter notes. Research like that conducted by the other panelists can be useful to the commission and its staff as it examines whether energy and ancillary service market reforms are necessary to address changing system needs in the evolving electricity sector.



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