The Power of Power Markets: Electricity Market Design in Advanced European Energy Transitions

As the energy transition advances, the costs of renewable energy decrease and renewable energy technologies mature. In this process, market design and regulation becomes increasingly important for enabling increasing shares of renewable energy in the system. In European energy policy, the process of revising current legislation on electricity (i.e. the Clean Energy Package) was characterized by the call for ‘making markets fit for RES’. The European Commission has expressed that the Energy-Only Market (EOM) is their preferred market model. It is supposed to facilitate increasing cross-border trade and integration of renewables. However, this will depend on the national designs of the EOM, which can vary substantially across countries. This paper compares electricity market designs in two regions that have deliberately chosen an EOM model: The German and the Nordic electricity markets. Both regions are comparable in size and overall market model. Moreover, they have promoted rapid deployment of renewable energy over the past 20 years. Interestingly, their market designs differ in one important respect: The Nordic region is divided into 15 price zones, whereas the German market has one price zone only. The zonal pricing design is a tool for managing grid congestions. In Germany, these congestions are managed by the TSOs through redispatch. The paper asks: Why have Germany and the Nordic countries chosen different approaches for congestion management and what are implications thereof for the energy transition in Europe? The main data consists of 20 quantitative interviews with key actors and stakeholder in the electricity sector. I also use electricity and market trading statistics and complement this with reports, consultation responses and position papers from public and private stakeholders. The paper applies institutional theory, which stresses the importance of path-dependence and institutional cultures for policy design and regulation. Further, the paper draws on insights from the literature on Large Technological Systems (LTS) and explores the role of so-called technopolitics when designing and developing socio-technical energy systems. Among the findings is that actors in the two regions have framed the issue of market design in diverging ways. The function of a price zone design is described differently in the two regions. In the German market, actors perceive a price zone design as an alternative to building a transmission grid without any constraints. In the Nordic market, the price zone model is argued to be one of the key design elements of the market model, which ensures cost-efficient distribution of resources. Some actors argue that the zonal pricing has contributed to the integration of more RE into the system, especially for intermittent wind energy in Denmark. In light of recent recommendations of the European Commission to split the German market into several zones, the findings provide important insights in why Germany have declined to do so. The paper illustrates that specific market design elements can influence the overall functioning of the European energy market. This might have important implications for the objectives of EU energy policy and the costs and pace of the ongoing transition.