TODAY’S STUDY: A Market-Driven Way To Grow New Energy
Using Lessons from Reverse Auctions for Renewables to Deliver Energy Storage Capacity: Guidance for Policymakers Maureen Lackner, Steven Koller, Jonathan R Camuzeaux. 24 January 2019 (Review of Environmental Economics and Policy)
As renewable technologies grow cheaper, intermittency is emerging as a critical challenge for achieving large-scale renewables deployment in the electric power sector. Energy storage is particularly well suited to help integrate renewables into the power sector’s energy mix because of its ability to store excess energy when prices are low, which can then be discharged when prices are high (i.e., energy arbitrage). Based on recent literature, existing data, and conversations with technical experts, this policy brief explores whether reverse auctions, a market-based tool widely used to procure renewables capacity, might also be cost effective for energy storage procurement. Past experience with renewable energy procurement and early evidence from battery storage systems suggest that reverse auctions are a valuable policy tool for driving down the prices of new storage capacity. However, auction design is important not only for competition and price discovery, but also to encourage the participation of developers of innovative technologies and to guarantee timely delivery of new capacity. In particular, we encourage policymakers to consider the multiple grid services that storage systems can provide in order to ensure that reverse auction frameworks accurately price and capture the value of storage system services in meeting electric power grid demand.
Energy storage systems can store energy in a form that can be converted back to electrical energy when needed, thus offering a promising solution to the challenge of intermittent renewable technologies, a critical constraint to decarbonizing the electric power sector (Chen et al. 2009). In addition to providing a wide range of valuable grid services,1 storage technologies have energy arbitrage (the ability to store excess energy when prices are low, which can then be discharged when prices are high) and reserve capacity (quickly dispatchable backup power) capabilities that are particularly well suited to supporting the integration of renewables into the U.S. electric power sector’s energy mix (Pickard and Abbott 2012; Condon, Revesz, and Unel 2018).
Although it is clear that policymakers should consider a wide range of technologies to meet their energy storage needs, this policy brief primarily focuses on battery storage.2 In the United States—currently the world’s largest storage market (Manghani and McCarthy 2018)—80% of total deployed large-scale battery storage uses lithium-ion (Li-ion) technology (U.S. Energy Information Administration 2018), and it is projected that in the next few years, the majority of U.S. demand for utility-scale storage capacity (grid-connected systems with nameplate power capacity over 1 megawatt [MW]) will be met by Li-on batteries (US Energy Information Administration 2018; GTM Research and Energy Storage Association 2018). There is not yet a consensus on optimal levels of storage to support renewables integration, and this is a key area for further research. However, one recent analysis suggests that as much as 10,000 GWh will be needed to support an electricity mix in the United States that is two-thirds renewables (Heal 2017). We conservatively estimate that the United States currently has no more than 10 percent of that amount of utility-scale storage capacity,3 and the quantity is likely much lower (U.S. Department of Energy 2018). Thus there is a need for innovative policy solutions that can quickly and cost-effectively increase energy storage deployment in the United States and elsewhere…
Lessons and Guidance for Effective Policy Design
Policy design affects auction results in terms of both price and delivery. Although designing auctions to achieve low prices is important, other characteristics of auctions help to ensure delivery of quality projects. Here we present lessons and guidelines aimed at reducing bid prices (guidelines 1–3) and encouraging innovation and delivery of new capacity (guidelines 4 and 5).
Guideline 1: Encourage a Large Number of Auction Participants
Economic theory suggests (Bulow and Klemperer 1996) and experience with renewables reverse auctions shows (Shrimali, Kondra, and Farooque 2016) that additional bidders increase competition. Prices are reduced not only because the cheapest technologies are less likely to be excluded from the process (Ferroukhi et al. 2015), but also because collusion and the exercise of market power become more difficult (Kreycik, Couture, and Cory 2011).
One way to expand the pool of bidders is through technology-neutral auctions, which allow a diverse set of technologies to compete. For example, in Chile, the minimum bid (US$29.10/MWh) in a 2016 technology-neutral auction came from a solar developer, at nearly half the bid of a competing coal company (Johnston 2016). However, this strategy may not be ideal when trying to advance a specific technology; in Germany’s first joint wind and solar auction, solar developers won all of the capacity, which is at odds with Germany’s goal for a balanced mix of renewables (Knight 2018).
Another way to boost participation is to signal consistent demand with an auction schedule and transparent administrative processes (Kreycik, Couture, and Cory 2011; del Rio and Linares 2014). For example, the number of bidders in South Africa’s auction program increased when organizers started hosting preauction conferences to explain rules and any changes (Ferroukhi et al. 2015).
Guideline 2: Limit the Amount of Auctioned Capacity
Auctions can also facilitate competition, and thus lower prices, by auctioning amounts of capacity that the market can easily supply. For example, researchers estimate that introducing a capacity limit significantly reduced winning PV solar bid prices in a South African auction (Shrimali, Kondra, and Farooque 2016). Auction designers can also limit individuals’ market power by capping capacity per bidder (Shrimali, Kondra, and Farooque 2016).
Guideline 3: Leverage Policy Frameworks and Market Structures
Recognition of the support provided by additional policies (e.g., tax incentives or mandating that utilities buy renewable electricity at an administratively set price via feed-in tariffs) may increase the effectiveness of an auction program.8 For example, low offshore wind auction prices in Denmark result in part from the government undertaking the risk and financial burden of site selection (Ferroukhi et al. 2015). In some cases, other procurement mechanisms may be better at supporting expensive projects or smaller developers (del Rio and Linares 2014).
Ensuring that storage systems are able to participate in capacity, energy, and ancillary services markets (as required in the United States under Federal Energy Regulatory Commission Order No. 841) may also reduce bid prices for projects that include battery storage because developers could then capture additional revenues from grid services beyond energy arbitrage (Federal Energy Regulatory Commission 2018). A recent 60 MW contract won by Fluence Energy in the UK’s Capacity Reserve Market highlights the importance of capturing the value from multiple grid services in auction frameworks, as the majority of this project’s revenue will come from frequency regulation services (Spector 2018).9
Guideline 4: Earmark a Portion of Auctioned Capacity for Less-mature Technologies
Policymakers can mitigate auctions’ tendency to choose large bidders with established technologies by taking a targeted approach to energy storage procurement (Kreycik, Couture, and Cory 2011; del Rio and Linares 2014), although this may increase prices. For example, Queensland, Australia is conducting a reverse auction for 400 MW of renewable energy capacity, which includes 100 MW earmarked for storage capacity (Queensland Government 2018). If the auction produces low prices, innovative projects, and reliable deployment, this storage-specific reverse auction model may be exportable to other jurisdictions.
There is some concern that a dominant energy storage technology (i.e., Li-ion) may prevent less-mature technologies from developing, despite their potential suitability to provide certain grid applications in the long run (Hart, Bonvillian, and Austin 2018). Thus policymakers may want to consider reserving some auction capacity for specific types of energy storage technologies to avoid this “lock-in” of a single storage technology.
Guideline 5: Balance Penalizing Delivery Failures and Fostering Competition
In general, auctions do not reward cautious bidding, producing a tendency for winning bidders to underestimate costs (Milgrom 1989).10 Although a certain level of failed deployment indicates healthy competition and risk taking, auction design should encourage developers to bid their true costs. Auction design can discourage underbidding by penalizing delivery delays, a symptom of underbidding (del Rio and Linares 2014).
Auctions can also establish upfront safeguards, such as requiring documentation of financial health, and completion bonds (Elizondo Azuela et al. 2014). However, there must be a balance between guaranteeing project completion and encouraging competition. One less stringent option is to plan for failed deployment by auctioning more quantity than necessary (Kress, Ehrhart, and Haufe 2017).
Generating revenues from multiple grid services can reduce energy storage bids; however, developers must still deliver the products for which they have contracted. For example, in 2017, Tesla’s Hornsdale Power Reserve, which uses Li-on technology, won a technology-neutral tender by the government of South Australia for new storage capacity. The contract stipulates that the 100 MW/129 MWh system must set aside capacity for specific grid services, including energy arbitrage, reserve capacity, network control, and frequency control (Australian Energy Market Operator 2018).
In order to build enough energy storage to support the majority-renewables electricity mix needed to achieve long-term emissions targets, policies will be required to foster innovation, drive down costs, and meet procurement targets. We have argued here that reverse auctions, which have been widely used to procure renewables capacity, are likely to become an increasingly popular mechanism for competitive procurement of energy storage. As with renewables, the success of storage auctions will depend on good design. Given the fundamentally different physical and operational characteristics of storage systems, it is crucial for grid operators and utilities to consider the multiple grid services that storage systems are able to provide to ensure that the value of these services is accurately priced and captured within reverse auction frameworks.