This is part 2 of a two-part blog articulating the view of Jonathan O’Sullivan of the Eirgrid Group, which has TSO responsibilities for the systems of Ireland and Northern Ireland. The view encompasses how the industry evolved to its current state, and where it needs to go from here to satisfy the goals and needs of electricity customers and society. Part 1 offered an original view on what customers really want, while Part 2 offers a thoughtful perspective on how Eirgrid plans to provide it.
Augmenting the Market to Accommodate these Resilience Services
Before considering how to remunerate for resilience services—ensuring the reliability of the grid—it is important to understand the nature of the goods and services in economic terms. Two dimensions are important: whether a good is rivalrous (is there a substitute or alternative for the service offered?) and whether it’s excludable (can a person who does not pay for the service be excluded from it?).
Classical electricity markets have implicitly considered energy as a commodity. It is rivalrous (for example, there are multiple suppliers or there are alternatives (I could use gas to heat my house)). And it is excludable in that if the consumer does not pay the bill, they can be disconnected.
The resilience of the power system, however, is non-rivalrous. There is simply nothing like having a resilient power system. Also, it is non-excludable to the person who does not pay their electricity bill. Through storms and contingencies, the economy still functions and traffic lights work. This is the guarantee that is implicit with the commodity consumers need to live their lives the way they want.
Ramifications of a Public Good
A fundamental consideration in constructing markets is the nature of the good. For commodities, microeconomics would have you build supply/demand equilibrium points and profit maximisation around the marginal price equal to the marginal cost. All energy market designs attempt to achieve this while making some small allowances for the vagaries of reserve provision and network limitations.
However, in public good markets, the use of curves to determine price is simply not possible or correct. How do you determine the correct level of defense spending, or how do you value the air we breathe? Good market design for public goods should allow choice and have some appropriate value set for them. In addition, in economics it is accepted that commodity markets simply underinvest in public goods.
Accepting that there is a value in the resilience of electricity systems, one has to estimate this value. This can be a challenge until it is realized that most consumers today would happily pay what they are already paying on a monthly basis for a reliable and fully renewable power supply. However, in this case, the marginal price in an energy market will be zero (solar and wind). In the case of Ireland and Northern Ireland, there are approximately 2.5 million homes (not to mention business and industry) that pay €2000 a year, equating to €5 billion a year from residential consumers. At the very least, as the price in the energy market diminishes with increasing renewables, the savings could be allocated to ensure that the system has adequate capability to facilitate that level of renewables. This is the essential philosophy behind the programme of work in Ireland and Northern Ireland started in 2008 to meet the target of 40% of electricity from renewable sources (RES-E) by 2020.
The Transfer of Value between Public Goods
However, this approach leads to only so much investment before increased costs are borne by the consumer. In a world where electricity is addressing decarbonisation and renewable requirements through the electrification of heat and transport, the argument can be made that the value provided in these sectors could be recovered in electricity costs. The argument that decarbonisation and renewable energy objectives are themselves public goods makes this transfer-of-value argument self-consistent and potentially transformational. In the case for Ireland and Northern Ireland, let’s say for the sake of argument that there was a €2 billion savings in financial penalties from the EU for electrifying heat and transport. It could be argued that if the investment costs in the electricity system required to electrify heat and transport were less than this, that up to €2 billion could be transferred from the national budget to ensure that the net cost to the consumer did not exceed the existing €5 billion that the consumers have demonstrated they are willing to pay.
Designing an Effective Mechanism to Allocate Value to Resilience
So with an established value for resilience including any transfer of public good value across and between sectors, how does one design an effective mechanism for the delivery of these services? First, it has to be accepted that these sources of resilience will change over time, and our industry process and procedures will need to evolve. How we transition from a power system with fully synchronous generation to one that has no conventional plants is non-trivial. It is essential to break down knowledge, measurement, and know-how barriers for utilizing new technologies if the benefits of the incentive for resilience are to be reaped. This needs to be a root and branch examination of how and why we are doing things the way we are today. When we in Ireland have done this examination, we have discovered significant unconscious bias in everything that is being done. We tend to plan and operate the system the way we always have without asking why. Systematically removing this bias is an essential and necessary step.
From the viewpoint of incentive mechanisms, there needs to be an assessment of whether or not the value of resilience is sufficient to drive the necessary investment. The assessment needs to consider the difference between a full investment cost for resilience and one that is incremental. In a world where wind and demand will dominate, it is likely that many of the necessary services will be obtained from incremental investments. However, some services will likely be required from fully new investments. The incentive mechanism will need to provide certainty, but also an ability to make a return on capital in high-wind worlds. In the DS3 programme in Ireland and Northern Ireland, dedicated to addressing the challenges of increasing levels of non-synchronous wind generation, we have managed this by introducing a scarcity scaler linked to real-time operation and the level of non-synchronous generation.
Preserving Space for Innovation
In addition, while there is a need for certainty for investors, this should not come at the expense of locking out innovation potential. For example, if there is a 10-year capacity auction, is this creating a barrier to innovation in the meantime and locking out those benefits to the consumer? In a world where the outcomes are pioneering and transformational, is it appropriate to create incentive mechanisms, such as a 10-year capacity payment, that lock out necessary innovation?
To get around this challenge, we have proposed a procurement framework where payments up to the value of the resilience will be paid to any technology that can provide the defined services. There are group processes every six months that allow proven service providers to get a contract. We combine this with a qualification trial process to allow for a necessary educational workshop on how we dispatch and measure new technology, which helps break down known and unknown barriers to utilizing these new technologies. While the rates paid under the framework are changeable, they are not changed unless there is a good rationale for doing so. This is managed through interactions with the regulators and the transmission system operator.
From Input to Output Regulation
A core part of the mechanism is moving our current practice of testing and obligations under grid code to actual performance monitoring during grid events. This in essence changes our approach from input to output regulation—pay based on what margin of resilience you need to maintain, given the conditions of the system. Then, in the event that they do not perform as promised, this will significantly reduce their revenues. The capability to be sure of performance when called to do it can be managed technically. However, someone like Warren Buffet, who will lend money to make the investment for system service provision, will back-end this risk off in a modified original equipment manufacturer (OEM) contract. Instead of looking for availability and efficiency, he looks to maximize performance capability. This is what we need in a high-renewables world—to make complementary investments with the renewables to maintain the resilience of the system that supplies the value, and not just the energy, to the consumer. Isn’t that what the policymakers, legislators, regulators, operators, and the consumer really want?