German development bank (KfW) forum with Peter Cramton on electricity market design

As the world transitions to net zero carbon emissions, it is necessary to electrify nearly everything. Electricity demand will double with rapid innovation in supply and demand. As the share of intermittent renewables, primarily solar and wind, grows and extreme weather events become more frequent, balancing supply and demand every second becomes more challenging, yet is a physical requirement of electricity.  Restructured wholesale markets provide real-time balancing. The market determines clearing prices that balance supply and demand, motivating operations in real-time to maximize social welfare.

Prices vary widely by time and place. Electricity, typically priced at about €50 per megawatt-hour, may have a negative price when renewable production is high and be thousands of euros during extreme weather. Participants attempt to manage this risk with forward trade, but there are several market failures that limit risk management and undermine efficient investment. Electricity markets have struggled with these challenges for decades.

This research addresses the critical market failures that have hindered efficient electricity investment and stifled innovation: incomplete markets, market power, and uncertainty. This research, once adopted, will expedite decarbonization. It leverages robust market designs to foster innovation and competition, bringing essential flexibility for reliable and resilient electricity in a setting with high renewable penetration. The research identifies the need to involve demand, particularly during extreme weather. Such a market significantly enhances price incentives, enabling efficient investment and operation of participants' resources. Retail consumers benefit. The result is a net-zero economy that provides reliable and resilient electricity at the least cost.