The political economy of electricity market reforms for the integration of renewables in Italy, California and the UK
Giulia Ragosa, UCL Energy Institute
Integrating a growing share of variable renewable generation in power systems requires adjusting the design of liberalised wholesale power markets to provide adequate long- and short term- coordination signals to market participants, and ensure adequate investment in flexible capacity. This study puts the recent wave of wholesale power market reforms aimed at enabling renewables integration at the centre stage of its analysis, using a political economy perspective to compare the forms that this process has been taking across different jurisdictions. Specifically, it aims to explore whether and how the interplay between economic and political factors has been affecting the formulation of these reforms across three jurisdictions: Italy, California and the UK. In doing so, it relies on comparative case study analysis and process tracing, drawing from multiples sources of evidence such as policy documents and interviews with key stakeholders.
In recent years increasing shares of variable renewable generation (VRE) such as wind and solar have been integrated into the power systems of multiple jurisdictions, at rates higher than 30% of the electricity mix. This raises significant operational challenges. In particular, the entry these technologies increases the need for flexibility, the ability of the system to manage uncertainty and variability in the supply-demand balance across timescales. Further, they alter the economic dynamics of price formation in power markets distorting investment signals for future capacity potentially undermining security of supply. As such, the ability of future power systems to cope with substantial growth in VREs is dependent upon the presence of appropriate incentives for investment in flexible capacity. This in turn requires adjusting the design of existing power markets to provide adequate long- and short term- coordination signals to market participants.
The adaptation of the regulatory and policy framework governing electricity markets for these emerging challenges is as a fundamental enabler of the energy transition. In fact, the power sector is often seen as a frontrunner in decarbonisation efforts and as fundamental to sustain the electrification of other sectors such as heating and transport. Reforms to the power market design for a renewable future are often described as twofold: first, they involve reinforcing the design of short-term markets, balancing markets, and long-term investment signals (i.e. capacity mechanisms and renewable energy subsidies); second, they involve changing the incentives of distribution networks and end-users to allow for a smarter grid with an increased role for active network users.
Hence, twenty years after the reforms were initiated to liberalise the electricity industry, many jurisdictions worldwide have embarked on a process of reforms to ‘fix’ their power market design to adapt it for a renewable future. These have been referred to as the ‘third wave’ of power market reforms (the first two ‘waves’ consisted of liberalisation reforms and the incremental adjustments that followed them). As with liberalisation, this ongoing process is not uniform and is taking different forms across jurisdictions.
This study puts the ‘third wave’ of power market reforms at the centre stage of its analysis, comparing the forms that this process has been taking across different jurisdictions. In analysing how market rules have been evolving across different contexts, it deviates from a purely economic approach by incorporating insights from the political economy literature. The basic assumption is that policy design choices are not merely driven by economic optimal solutions, instead, they are shaped by the interplay of economic and political factors. As observed by Leautier (2018) “policymakers never fully embrace economists’ prescriptions […] policymakers incorporate legitimate political concerns in electricity markets design.”
The political economy perspective is thus very useful for understanding policy change in real-world settings as it offers analytical lenses to study the constellation of actors involved in decision-making, their interests and motivations, as well as the mechanisms through which they attempt to shape policy. Policy design outcomes are thus understood as a function of the mechanisms of influence used by groups with stakes in decision-making, and the institutional and ideational context in which they operate.
In summary, this study adopt a political economy perspective to study the process of adaptation of liberalised electricity markets in the context of emerging decarbonisation and security of supply objectives. More specifically, it aims to explore whether and how the interplay between economic and political factors has been affecting wholesale power markets reforms enacted to cope with a growing share of variable renewable generation across three jurisdictions: Italy, California and the UK.
It hence seeks to answer the following research questions:
1. What are the key wholesale power market reforms enacted so far in the UK, Italy and California to integrate a growing share of renewables on their power systems?
2. How differences in the political economy of these power systems affected the evolution, scope and nature of recent reforms in wholesale power markets to enable VREs integration
The objectives are as follows:
• To identify and analyse key recent policy changes aimed at adjusting wholesale power market design for VREs integration across In Italy, California and the UK
• To map out the constellation of interests, mechanisms of influence, institutional and ideological components that have characterised each reform process
• To determine whether and how these conditions have interacted to shape key policy debates and outcomes across the cases
• To compare these interactions and their outcomes across the three jurisdictions to draw out theoretical and policy insights
In order to understand exactly how, and how far political conditions have influenced the policy process, it is necessary to understand exactly whether, why and how different actors sought to shape policy and the specific institutional conditions that determined their success or failure. As such, this study relies on comparative process-tracing analysis. By focusing on the process of policy formation in a systematic way, process tracing provides a useful tool to unpack the specific dynamics influencing the outcome of interest; while the comparison across the cases allows to isolate key conditions that are conductive of a certain outcome and to draw some generalisable insights.
The UK, Italy and California were selected as they exhibit some characteristics that make them particularly interesting to compare. First, they have similar market sizes, a comparable generation mix and a similar level of economic development. Further, the IEA (2018) analysis places these power systems in a similar VREs integration phase and, as for 2019, they all exhibited high renewable generation shares in their supply mix (36% in California; 26.5% in the UK; 34.7% in Italy). However, natural and geographical endowments coupled with historical policy decisions have led to important differences. For example, while the electricity markets in all three jurisdictions have all undergone liberalisation, they have done so at different paces and modalities, which is reflected in current institutional configurations. They diverge in the number and nature of key actors participating in the markets, flows of finance, relationships with governance entities, capacities of regulators, the relative strength of demand-side/consumer interest groups, as well as the ideational context in which this process is unfolding.
These differences are likely to lead to divergence in the political economy of power markets, both in terms of economic dynamics such as economic dispatch and price formation due to the underlying technical characteristics of demand and supply, as well as for the configurations of interest groups and their ability to influence the policy process in the context of varying institutional and ideational contexts.
Evidence will be drawn out of multiple sources of information including mission statements by organisations, media reports, submissions to government consultations, sponsored research publications, records of meetings in expert forums, and interviews with interviews with individuals directly involved in the process of policy development as well as close observers. Analysis of both quantitative and qualitative data will be necessary to draw out important information such as the nature of ownership of key assets in the power system, market shares, revenue streams, locked-in investments, people employed in and turnouts of given industries etc.
Contribution to theory and practice
First, this study aims to fill an important empirical gap in the literature. Economic theory has gone a long way diagnosing and explaining the current issues arising from integrating renewables into the power system (See for example: Green and Leautier 2015; Pollit et al. 2019; Fang et al. 2018; Newbery et al. 2017; Joskow 2019; Botterud 2018). However, functionalist accounts alone are not able to explain the real-world implementation of power market reforms as they do not account for contextual political and institutional factors. Institutional theory and the political economy approaches offer a solid analytical basis for studying these dynamics across different contexts. Previous research focusing on various energy policy fields has found that political factors such as the nature of interest groups and ideologies can significantly impact decision-making processes, determining the nature, the scope and speed of policy change (Kern 2011; Biber 2017). More relevant to the issue of power markets, existing studies drawing from the political economy tradition have offered compelling analyses of the process of liberalisation reforms, explaining variation in outcomes across different jurisdictions in terms of political, economic and historical factors (See for example: Erdogdu 2013/2014; Guerriero 2018; Correljie and De Vries 2008). However, with a few exceptions, political economy lenses have hardly been applied to the issue of reforming competitive electricity markets for the integration of VREs (Exceptions include: Lockwood et al. 2020; Galwel et al. 2017; Leautier 2018). This study hence poses to fill this gap by providing a systematic account of the political and economic institutional conditions characterising the ‘third wave’ of electricity market reforms. As such, it aims to contribute to the wider understanding of the possible repercussions of the economic and political variables for power market design by collecting data and comparing cases within an understudied domain.
Second, this study has important policy implications. As pointed out by Kern and Rogge (2018:2): “Opening up the black box of policy processes may assist in developing policy recommendations that are better informed about the politics of policymaking and implementation and therefore potentially stand a better chance at being adopted and sustained.” Although studies of policy processes in the field of electricity markets remain are rare, they are very useful for understanding the dynamics of the sector’s evolution and for recommending the governance arrangements needed to accelerate the clean energy transition (Lockwood 2020). Additionally, research in this field has tended to focus on one single element at the time (e.g. the political economy of capacity markets) rather than looking at different aspects together. It is argued that this is problematic given the systemic nature of designing electricity markets for addressing security of supply and flexibility issues associated with integrating VREs. Hence, this study brings a novel perspective by addressing a combination of measures and their interactions, which will allow it to produce more relevant insights for decision-making in real-world settings (Kern and Rogge 2018). Finally, comparing experiences across different jurisdictions might highlight the emergence of best-practice pathways or, alternatively, that best-practice differs among different power systems and no consensus has yet emerged by on the best way forward to decarbonise our power system