An organised flexibility market requires organisation

Cortexo and Our Energy are committed to action that results in the electricity system and market being able to meet the challenges and opportunities of accelerated electrification. 

We’ve talked about having a plan to unlock the value of distributed energy resources (DER) and flexibility, founded in these four principles:

 — Clear policy leadership to coordinate the transition and hold everyone accountable 

 — A long term view which focuses on the things which set the critical path 

 — Being inclusive and making sure all voices are heard, particularly the people the whole thing is designed for 

 — Learn by doing, using pilots and trials to find what works.

Our view is that the plan really needs to focus on the adoption of a flexibility-first requirement for network operation and asset management. 

But, the flexibility-first approach only works when the electricity sector embraces digitalisation and flexibility is a feature of system and network operation.

Another necessary condition is to develop an organised flexibility market.

Markets are not organic

Markets are not organic (with the obvious exception of your local farmers’ market).

Efficient, competitive, markets exist because someone organises the market to make sure buyers and sellers can be confident the terms of trade will be reasonable and works to minimise transaction costs. 

Sometimes it’s helpful to go back to basics – on markets, Ronald Coase tells us that detailed rules are necessary for markets to approach the competitive ideal, with this insight borne out by looking at 100 years of evolution of exchange-traded markets for all sorts of commoditised goods and services (Note 1).

Expecting an organic ‘market-led’ outcome for flexibility services with ‘efficient’ terms of trade that are arrived at through some amicable process involving willing buyers (network operators) and willing sellers (DER owners) ignores the experience of over 20 years with the local wholesale electricity market (or any other market you care to name). 

Given the central role that DER and flexibility will play in accelerating electrification and decarbonisation, and in helping to avoid a nasty power price shock, waiting on some organic (perhaps better expressed as magical) process is a luxury our communities, the economy and the environment cannot afford.

An organised flexibility market needs four things

An organised flexibility market needs four things to get started:

1. Product specification, and product performance requirements

2. Consistent terms of trade

3. Pricing which reflects the value of the product

4. A commitment to learn by doing and refine the terms of trade and exchange over time.

This is not a complete list. These are the things necessary for growing a flexibility market, building liquidity and learning by doing (an organic process can only occur where the right soil conditions exist).

Product specification – what are the flexibility services actually?

Markets rely on a well understood and well accepted specification of the product being exchanged – flexibility services are no exception.

A flexibility lexicon has been set out by the Innovation and Participation Advisory Group. It draws on the extensive thinking on flexibility in the United Kingdom where the Energy Networks Association specified flexibility services (uses) in 2018. These flexibility services – now being routinely procured by network operators – are: 

 1. Sustain (scheduled constraint management). Used to manage network congestion to prevent localised outages, eg, if a network fault coincides with a peak demand period. 

 2. Secure (pre-fault constraint management). Used to manage congestion on the network, usually weekday evenings. 

 3. Dynamic (post fault constraint management). Used to support the network during specific fault conditions, often during maintenance work. 

4. Restore (restoration support management). Used to support the network during unexpected faults that occur as a result of equipment failure. 

These flexibility products reflect the what, when, how and why of the service being delivered based on the specific technical and performance requirements and the value to the network operator. 

Given electricity networks the world over are doing the same job dealing with the same laws of physics these product specifications are a reasonable starting point for developing equivalents for Aotearoa New Zealand.

Things to consider through the product development process include:

 – How to achieve a nationally consistent specification? Multiple variations of the same product would increase transaction costs and slow development of a flexibility services market.

 – What is the interaction with rethinking of planning criteria and asset management decision-making? Planning and operating practices will determine when, where, how and why flexibility services are used. Traditional practices may not include flexibility services as an option.

 – What product testing is needed?

Consistent terms of trade

Consistent terms of trade would reduce the hassle of developing a flexibility services market. Having pre-defined commercial terms covering things like product specification, performance requirements, procurement approach, and obligations for liability and costs would help to reduce unnecessary variation in contract terms and help to make the buyer and seller confident that the terms of trade are fair and reasonable. 

The Incoterms (international commercial terms) are a possible guide to defining common contractual practices. The incoterms are a global standard used to inform sales contracts without concluding a contract or to determine the price of the good or service.

The thing to remember is the flexibility services market is in its infancy. It’s worth asking whether detailed and comprehensive terms of trade will encourage or hold back developing a liquid market. Particularly when no-one has any real practical experience with the what, when, how and why of delivering a flexibility service (making contract terms defining how this should be done an exercise in speculation).

Pricing which reflects value

The flexibility services market will emerge because flexibility is valued and remunerated. Liza Minelli said it best, ‘money makes the world go round’.

At the moment, flexibility is not consistently or transparently remunerated. This is largely because flexibility is not valued and so is not used.

The value and pricing of flexibility services needs to be discovered. This discovery process is intimately linked to rethinking of planning, forecasting and operating practices and determining the what, when, how and why of using flexibility services.

There are a few things to consider through the value discovery process.

 – What costs can be avoided using flexibility services? How much is the flexibility service worth? How is that calculated?

 – How to make sure consumer costs are considered in the calculation of value, not just supply-side costs? This is quite important. Costs incurred by consumers through reduced amenity or unintended externalities need to be explicitly considered, for example to ensure the pricing decision does not result in over-investment by consumers in larger-than-necessary hot water cylinders. 

 – What is the pricing mechanism? What outcome is achieved from direct pricing signals (via a flexibility contract) versus indirect pricing signals (via distribution pricing)?

The ripple control service is unlikely to be a useful basis for establishing the value and pricing of flexibility. The discount offered to households for control of their hot water cylinder is not typically calculated based on value available or costs avoided. 

Learning by doing

A flexibility services market will not emerge fully formed and perfect one morning. It will take time. Mistakes will be made. Experience built.

Learning by doing, moving from pilots and trials to product testing to production will be necessary to identify capability requirements and build liquidity.

There is significant opportunity to expand the use of pilots and trials in Aotearoa New Zealand to support more informed policy making by moving from the present preference for a closed shop, siloed approach to a more multilateral, multi-party approach which emphasises sharing of experience and insights. 

Learning requires investment and commitment. Setting up and coordinating multi-lateral market-like pilots will not be straight-forward.

Essential to the learning-by-doing process will be obtaining a social licence for access to consumer DER. Energy Consumers Australia has highlighted the role of a social licence for control of DER in a successful transition. 

The basic idea is that flexibility users will need to obtain the “informal permissions granted by stakeholders for government or institutions to undertake decision making on behalf of energy consumers as to how they operate their DER systems, above and beyond what is required by law”. 

A take-it-or-leave-it approach will not be sufficient or appropriate to access the value of all available flexibility resources.

Build a field of dreams (and a cheaper power system)

Build a flexibility services market and DER owners will come. We should then get a cheaper power system that is more reliable, more resilient and lower carbon. Not to mention more competitive and democratic. 

This outcome will not be achieved at the pace needed to support rapid electrification without someone organising the market and appropriate regulatory intervention.

That regulatory intervention needs to involve someone organising the market by providing a consistent specification of the flexibility product and the what, when, how and why of using flexibility services, providing basic terms of trade and making sure pricing reflects value.

Importantly, the regulatory intervention doesn’t need the regulator leading. Rather the regulatory role can be to provide a safe environment for experimentation and embed the results of the learning by doing process as experience develops into good industry practice.  

Flexibility from DER will not become a feature of network, system and market operation at the pace required without clear rules to govern the exchange. Clear rules are even more necessary given the complexity of the electricity system and market and the inherent conservatism bred by the politicisation of pricing and the lights going out.  

Next time

To be continued…in the final article of this series we will talk about a plan for accelerating electrification.

Note 1:   Thanks to Sapere for this reference in their advice on Price discovery in 100% renewable energy markets. See Ronald Coase, The Firm, The Market and The Law. Chicago University Press, 1988, for Coase’s views on markets and regulation. 

Cortexo and Our Energy are committed to action that results in the electricity system and market being able to meet the challenges and opportunities of accelerated electrification. 

We want to help lead the conversation about how, when and what the electricity sector needs to do to accelerate electrification and to show the way by trying things out. 

To see what Our Energy and Cortexo are doing together to accelerate electrification you can have a look at this blog entry

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