Should Electricity Market Designs Be Improved to Drive Decarbonization?

Wholesale electricity spot markets of different variants have been operating in most developed countries and around 20 percent of their developing counterparts. Although these markets have by and large stood the test of time, their ability to decarbonize power systems in tandem with carbon, renewable, and other policy drivers raises questions about the efficacy of the existing market designs. Expert opinions in the academic and industry literature are divided on this issue, ranging from very few changes to sweeping changes. This review of the literature suggests that in the short term, there is prima facie no reason to believe that the existing market designs are inadequate. At least, there are robust mechanisms in the current markets for energy, capacity, and ancillary services that can be mixed and matched to accommodate renewable energy and storage, and indeed substantial utility-scale renewable energy additions have taken place in several developed countries that are traded through wholesale markets. In the medium term, there may be a need for additional mechanisms. Opinions begin to diverge on this issue for high-variable renewable energy systems and places where markets, especially voluntary net pool markets, have tended to be illiquid due to the presence of legacy fuel supply and generation contracts. Markets like those in India and South Africa, with liquidity in the day-ahead market below 10 percent after more than a decade since they started, are clearly not working, regardless of their decarbonization roles. There is no reason to rethink a complete overhaul of the market design, at least not until there is more evidence that the current systems are not working and empirical evidence in support of a new mechanism. A fuller quantitative examination of the market design options building on the insights derived in this review is a critical task. Future research efforts should construct country case studies to assess the performance of alternative market design proposals