Why the Sustainable Provision of LowCarbon Electricity Needs Hybrid Markets: The Conceptual Basics

Authors

Jan Horst Keppler, Simon Quemin, Marcelo Saguan

Abstract

Deep decarbonization of energy systems poses considerable challenges to electricity markets and there is a growing consensus that an energy-only market design based on short-term marginal cost pricing cannot deliver the adequate levels of investment and longterm coordination across actors and sectors. Based on the vivid example provided by the evolution and adaptations of the European electricity market design, this paper first discusses several shortcomings of energy-only markets and explains how ad-hoc policies that intend to address these limits also have limits of their own, notably due to a lack of systemwide coordination. Second, it characterizes how deep decarbonization exacerbates these issues, raises short- and long-term uncertainty in energy-only markets, and how private investment in capital-intensive low-carbon technologies tends to fall short of the social optimum. Ambitious emission reduction targets (e.g. net zero by 2050) thus require an evolution of market design, which we argue should shift towards hybrid market design regimes. The key feature of a hybrid design is the separation of long-term investment decisions from short-term operations through a careful and balanced use of competitive and centralized design elements to coordinate and de-risk investment. Finally, a conceptual analysis of the evolution of different market designs in a historical perspective shows how hybrid markets constitute the contemporary form of long-run marginal cost pricing that is appropriate for meeting deep decarbonization objectives with radically reduced uncertainty and at least private and social costs.