Markets for low carbon, low cost electricity systems

This research paper by the Climate Policy Initiative argues that existing electricity market designs, based on short-term marginal costs, are ill-suited for a low-carbon transition dominated by variable renewable energy (VRE). The authors propose a bifurcated market model—separating a long-term 'energy market' for commodity production from a short-term 'delivery market' for flexibility—to lower financing costs for capital-intensive assets and provide clearer incentives for flexibility resources like batteries and demand response.

• Existing electricity markets based on short-term marginal costs face four primary failures under high penetrations of variable renewable energy (VRE): hourly prices may drop to zero or below, the link between natural gas and electricity prices becomes illogical, financing costs for generators may rise due to increased risk perceptions, and incentives for innovation in new technologies are blunted.
• Low-carbon energy sources, including wind, solar, nuclear, and fossil fuels with carbon capture, are highly capital intensive, meaning that upfront project costs and financing are the primary determinants of the lifetime levelized cost of energy (LCOE). For wind and solar, variable costs are negligible or non-existent.
• The authors propose a two-market model to manage the transition: an 'energy market' for commodity electricity production using long-term auctions to enable low-cost financing for capital-intensive resources, and a 'delivery market' to provide incentives for flexibility (when and where energy is needed) through locational and time-varying prices.
• The proposed energy market would use long-term contracts (e.g., 15-30 years) to reduce risk for investors, which could lower the cost of wind and solar energy by over 10% and potentially reduce costs by an additional 15-20% through new financial instruments for institutional investors.
• The proposed delivery market would utilize locational marginal pricing to clear the difference between demand and production from contracted generators, sending strong signals for energy storage, demand shifting, and transmission investment.
• In Germany, the lack of specified compensation for curtailment during negative price hours increases risk for debt investors, which reduces leverage and raises the weighted average cost of capital (WACC) for wind projects.
• A low-carbon system reliant on over 80% variable renewable energy could become cost-effective by 2030 even without carbon pricing, potentially costing less than a new system supplied exclusively by natural gas.
• The paper identifies several challenges in integrating the two-market model, including creating incentives for energy market participants to reduce long-term flexibility needs, integrating transmission and distribution costs, and maintaining system security and reliability.
• The authors cite Brazil's electricity market as an example where long-term energy auctions are central, requiring all demand to be 100% covered by energy contracts on an annual basis, which has facilitated investment in hydro generation.

APA

Pierpont, B., & Nelson, D. (2017). Markets for low carbon, low cost electricity systems. Climate Policy Initiative. https://www.climatepolicyinitiative.org/wp-content/uploads/2017/10/CPI-Markets-for-low-carbon-low-cost-electricity-systems-October-2017.pdf

Chicago

Pierpont, Brendan, and David Nelson. Markets for low carbon, low cost electricity systems. Climate Policy Initiative, 2017. https://www.climatepolicyinitiative.org/wp-content/uploads/2017/10/CPI-Markets-for-low-carbon-low-cost-electricity-systems-October-2017.pdf.

Wikipedia

{{cite report |last1=Pierpont |first1=Brendan |last2=Nelson |first2=David |title=Markets for low carbon, low cost electricity systems |publisher=Climate Policy Initiative |date=September 2017 |url=https://www.climatepolicyinitiative.org/wp-content/uploads/2017/10/CPI-Markets-for-low-carbon-low-cost-electricity-systems-October-2017.pdf |access-date=17 August 2026 |via=Climate Insights Directory}}

BibTeX

@techreport{pierpont2017markets, author = {Pierpont, Brendan and Nelson, David}, title = {{Markets for low carbon, low cost electricity systems}}, institution = {Climate Policy Initiative}, year = {2017}, month = sep, url = {https://www.climatepolicyinitiative.org/wp-content/uploads/2017/10/CPI-Markets-for-low-carbon-low-cost-electricity-systems-October-2017.pdf}, urldate = {2026-08-17}, note = {Indexed by Climate Insights Directory} }