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Can Electricity Markets Survive This Energy Crisis? - Barış Sanlı

Yes, they will. The prime example is California. After the 2001 California energy crisis, the electricity market reforms survived in California, but with a twist. This time there are several issues like accommodation and fostering zero marginal cost resources, the shift in demand for services, and a new type of contract.

The first word to be delved into is a crisis. Is it an energy crisis? From the US view, it is not exactly. Natural gas prices are not at their highest. Oil prices have hiked to a closer level, but we do not consume crude oil but products. The oil product prices have reached record high levels. This was more like a post-covid correction with difficulties in physical allocation. This is a full-blown energy crisis with record high gas prices on the European side. There is a demand destruction, and there is societal destruction. Two folds increase may be considered as a price level for demand destruction, but ten fold price hike is a much bigger beast to feed into societal disturbances.

In detail, there are shifts in demand for the electricity system. The asymmetries in the system have increased, such as winter-summer supply-demand security due to solar. The known unknowns, such as “wind drought,” are a major issue. The highest demand for electricity in summer does not correspond to the tightest supply-demand balance because solar has changed the game from demand for supply to demand flexibility.

How about zero marginal cost resources in the market mechanism? The marginal pricing has merits. But just like iPhones operating in certain temperature ranges, orthodox tools are designed for a spectrum of events. Suppose the system perturbs beyond these options, and the effectiveness of tools decreases. That is why the operating reserve marginal curve works in a tight market but not in normal conditions.

There are lots of mechanisms to implement in new age electricity mechanisms. For fossil fuels, it looks as if marginal pricing with hard/soft caps is favorable now. Reform is not easy, and even in California, it took years.

But there are other issues and lessons to be learned from California. As we have seen in the aftermath, traders have exploited every market deficiency with gaming procedures named Star Wars characters. The European gas market is definitely not much different. We will probably see how traders have manipulated the benchmark. Benchmarks are like whales. When the water is shallow, it gets easier to be hunted.

A green electricity market alone is impossible, but a hybrid model is more foreseeable. Electricity markets are even hybrid now because there are real-time operations and promises for real-time. This time, on-demand and on the available market split is much more favorable. But in the inception, data and connectivity have laid the groundwork for electricity market operations. That was in the 1990s. Now we have more sophisticated tools than ever. The markets will shape accordingly.

Canan Özden Schilling’s book “The Current Economy: Electricity Markets and Techno-Economics” is a must-read for these times and I am still fascinated by the observations in that book. Electricity markets are a system that glues engineering with economics. They are basically live on data tables and work on copper wires. If a reform happens, it will make the most of the current engineering and economics understanding. But markets are also institutions of accumulated experience, understanding, and conflicts. We have to accept this as a reality humbly.