Current Tools and Policy Challenges in Electricity Markets
In 2017, I have been awarded an ERC Consolidator Grant for a five year period, Sept 2018-2023.
More information can be found at EnergyEcoLab
Main research question:
I propose to push out the frontier in the area of Energy and Environmental Economics by carrying out policy-relevant research on a pressing issue: how to design optimal regulatory and market-based solutions to achieve the low-carbon transition at least cost.
Main research topics:
The European experience provides unique natural experiments with which to test some of the most contentious policy issues that arise in the context of electricity markets. These include the potential to change households’ electricity demand patterns through dynamic pricing, the scope for renewables to mitigate market power and depress wholesale market prices, and the design and performance of the contracts and auctions for renewable support.
I will rely on cutting-edge theoretical, empirical, and simulation tools to disentangle these topics, while at the same time providing key economic insights that are relevant beyond electricity markets. On the theory front, I propose to develop new models that incorporate the unpredictability of renewables to characterize strategic behavior and optimal bidding in these markets. This is a key, yet broadly omitted ingredient in previous analyses. In turn, my models will provide structure and testable predictions for my empirical and simulation analyses, for which I will rely both on traditional econometrics for causal inference as well as on state-of-the-art machine learning methods to construct counterfactual scenarios.
As a source of rich and highly disaggregated data, electricity markets open up exciting opportunities to explore issues that, while being of general interest, cannot be studied in other sectors in such a great detail. My research will also provide methodological contributions for other areas – particularly those related to policy design and policy evaluation. The aim is to provide sound policy answers through the lens of state-of-the-art methodologies.
The conclusions of this research should prove valuable for academics, as well as to policy makers to assess the impact of environmental and energy policies and redefine them where necessary.
I will count with the support of a team of other first-class economists. Notably, my current co-authors Gerard Llobet (cemfi), Juan Pablo Montero (PUC-Chile), Mar Reguant (Northwestern), David Rapson (UC Davis). Imelda has joined the team in September 2018 as a post-doc. The team will further consist of 2 PhD students and visits by senior faculty.
In this article at the EAERE magazine, I discuss some initial questions of the project.
Overview of the project’s progress
First, we seek to understand the strength of pricing incentives to incentivise a more active role of electricity consumers. This issue is key for the deployment of renewable energies, whose availability is linked to the changing weather conditions. Consumers’ response to price changes would allow transferring demand from periods with low to high renewable availability, leading to better use of the renewable resources and to a reduction in the need for conventional backup capacity. As many countries around the world are devising new electricity pricing schemes, it is paramount to understand whether facing consumers with time-varying prices is sufficient to achieve such goals.
Second, while the objective is that power markets will become carbon-free in two decades, it is not clear how such markets will perform. This issue is critical to understand: whether final consumers will benefit from the energy transition and whether electricity markets provide enough incentives for firms to invest in renewables and storage. Our project seeks to provide key insights into these issues.
Third, beyond the current market arrangements, we seek to identify the best policies to promote investment in renewables and storage. Taking into account firms’ strategic behaviour is important to understand whether the market structure would affect the effectiveness of such policies.
Regarding the second area of research, we have completed the working paper “Auctions with privately known capacities” (with Gerard Llobet). In this work, we build a model of competition in renewables-dominated wholesale markets for electricity. Competition-wise, there are two key differences between conventional and renewable technologies. First, the marginal cost of conventional power plants depends on their efficiency rate and on the price at which they buy fossil fuel. In contrast, the marginal cost of renewable generation is essentially zero. Second, the capacity of conventional power plants is well known, as they tend to be available at all times. In contrast, the availability of renewable plants is uncertain and intermittent. Hence, the move from fossil-fuel generation towards renewable sources will imply a change in the competitive paradigm, towards one in which marginal costs are known (and essentially zero) but firms’ available capacities are private information. Under this new paradigm, our paper shows that renewables mitigate market power as compared to conventional resources. However, renewables will not in general make electricity markets immune to market power and will lead to price volatility. The conclusion is that deploying renewables without further market design changes will not be enough to achieve efficient outcomes. Regulators will have to rely on other market designs if they aim at fully eliminating market power.
We have also completed a second working paper, “Market Power and Price Exposure: Learning from Changes in Renewables Regulation.” We demonstrate that the way regulators pay for renewables output is a key determinant of market performance. In particular, both theoretically as well as empirically, we explore the market impacts of two regulatory changes that took place in Spain in 2013-2014. We show that paying renewables according to fixed prices (as opposed to paying them at market prices plus a premium) mitigated market power, leading to both greater efficiency and higher consumer surplus. Beyond electricity markets, these results suggest that addressing market power directly (rather than indirectly through arbitrage) induces more efficient outcomes.
Regarding the third area, we have completed the paper “Technology neutral versus technology-specific procurement” (with Juan Pablo Montero), in which we analyse the design of policy instruments for procuring renewable capacity. In particular, we compare the use of technology-neutral auctions (in which all technologies are allowed to compete) versus technology-specific auctions. We also assess the use of quantity instruments (such as auctions) versus price instruments (such as tariffs). We show that these choices have fundamental impacts on technology choices and the costs for consumers of procuring the new investments. The implications of these results apply to all procurement settings in which goods or services can be provided with multiple technologies.
The advent of the COVID pandemic has also pushed us to analyse further project-related questions. In particular, in “Degrowth versus Decoupling: competing strategies for carbon abatement?” (with A. Lacuesta, and M. Souza), we compare two alternative strategies for reducing emissions through the lens of the natural experiment brought about by the pandemic: “degrowth” versus the “decoupling”. We find that the latter gives rise to several orders of magnitude lower costs of carbon abatement.
Our work so far has allowed us to interact with energy and environmental economists worldwide. We expect that these interactions will lead to further collaborations in the figure. We have also had the chance to interact with several policymakers and practitioners’ forums in which we have shared the main results of our research.