What is a common principle in the industrial design, that the shape of a product should be based upon its intended function should also apply on the market design of any commodity market.
Looking into the electricity market in Germany and its market design, the “shape” of the market is the pricing of delivered electricity, which gives a price per produced MWh. Due to the assumption of perfect competition between producers (let us assume, that it is the case, although we have seen differently in the last decade) they will offer in the market the minimum amount of money that they need to cover the basic costs. These offers are assumed to be the short run marginal costs of the power production and the bids from the demand side is the maximum willingness to pay for electricity until the consumer can substitute electricity with a different energy type or produce electricity on their own. The result is a market price hopefully for all market participants higher than the short run marginal costs and lower the costs for substitution or own production. The “shape” in this case is the energy-only-market as we know it today.
The “function” of the market is for the producers the refinancing of all their operational and capital expenditures (OPEX and CAPEX). At least that is the long term goal. In today’s market situation in Germany, where more 25 % of all produced electricity come from energy sources, which do have low or zero short run marginal costs the function of the market is not guaranteed anymore. Market prices have been in the yearly average lower than production costs. For combined cycle gas turbines the spreads have been negative since several years and for coal power plants the spreads are slightly positive, but are not able to cover all OPEX and CAPEX.
This situation leads to two crucial questions: How can we change the “shape” of the market, that it will follow the “function”? And a more critical question: Has the “shape” of the market in the past been sufficient to fulfill the “function” at all? Finding an answer to the last question would mean starting a revolution in the whole liberalized electricity market. For answering the first questions an action plan is needed. If we do think, that the “shape” of the market is generally ok, but needs some profiling, small adaptations of the todays energy only market are enough to follow again the “function”. But there is also a fraction in the market that thinks the current “shape” is not sufficient, we do need a different “shape” or at least a secondary market with a different “shape”. This market in combination only with the energy-only-market will fulfill the “function” again. This fraction supports a new capacity market design.
The politicians in Germany are going to decide within the next months, which “shape” they would like to have in the electricity market. It is very likely, that the decision will lead to small adaptation of the current market design, in the hope, that the form will follow the function again.
