By Eric Gimon

President Biden’s goal of 100% clean electricity by 2035 would supercharge America’s clean energy industry, create hundreds of thousands of jobs and help prevent the worst consequences of climate change. Multiple states have already required 100% clean electricity by midcentury, and many utilities are voluntarily adopting these goals. But realizing these goals requires market designs capable of efficiently integrating a high fraction of renewables, leaving policymakers with important unanswered questions.

Policymakers must determine how wholesale markets built around short-term marginal cost pricing are supposed to work when large fractions of electricity are generated at zero marginal cost? And how can we secure rapid investment in new clean resources and rapidly retire fossil fuel generation if prices paid to these new resources keep falling, even with the most supportive policy?

Answering these questions is easier if we expand consideration of wholesale electricity markets to the entire “energy markets cascade,” a concept describing the flow of contractual agreements for electricity from long-term markets, power purchase agreements, and hedges to year-, month-, day- and hour-ahead commitments, to real-time spot markets. This course connects long-term resource investment to the day-to-day running of spot markets. Capital will flow efficiently along this path if the energy markets cascade follows three design principles.

First, the cascade should trade in only one underlying commodity: delivered megawatt-hours of electricity. Just as a cascade is one current flowing from pool to pool, the markets in our cascade best align if they all trade the same product. Any market in this sequence could experience changing conditions and forecast errors, but if they are all trading in megawatt-hours, the next market down can account for shifting situations by trading or adjusting given commitments.

Consider a wind developer with long-term contracts in place to secure financing. As their electric output delivery approaches, the developer often anticipates real-time market excess or shortfall from what they promised. To minimize the gap between financial commitment and physical delivery, developers can use a market with the most appropriate time frame depending on expectations, always keeping risk at acceptable levels.

Second, participation in the longer-duration markets should be voluntary. In a compulsory long-term market, participants cannot act just on volume and price expectations: A central authority provides targets, fixing demand irrespective of price. Voluntary markets, on the other hand, can balance diverse future outlooks.

For example, an electricity customer that deems current long-term prices too high might not commit to buy what they need until closer to delivery. This behavior lowers demand — and therefore prices — higher up the cascade and raises prices lower down, realigning prices across all markets.

Finally, markets in the cascade should be equal-access, transparent and liquid. Nondiscriminatory access fosters diverse and independent participation in the energy markets cascade, creating more potential buyers and sellers. This drives efficient capital allocation, because participants can more easily trade to adjust their positions according to need, developing a common basis for the current value of electricity contracts.

Efficient capital allocation also requires transparency and liquidity. Transparent public prices and information of trading volumes sharpens common understanding. Liquidity improves with a standard set of energy markets cascade products diverse enough to address different stakeholder needs yet limited in number so that sufficient trading volumes exist to value products at regular intervals.

Market Reforms for a Safe Climate Future

Today’s markets are failing to meet these three principles each in their own way. PJM, NYISO and ISO-NE have mandatory, not voluntary, capacity markets and stand accused of bias toward legacy resources. In MISO, SPP and CAISO, utilities hold the upper hand on information about what the market and new technology can offer, confidently asserting primacy over the integrated resource plans that shape procurement. This chokehold risks ignoring potential savings from inconvenient (for the utility) retirements, inertia in seeking new solutions (e.g., batteries over peakers), and persistent bias against demand-side resource participation or competition from distributed energy resources.

We must design wholesale markets to support long-term investment in variable renewables and complementary resources through better risk management tools. Legislators, regulators and market operators who want a fully decarbonized grid should look beyond the spot markets to consider the entire energy markets cascade and enact reforms to better align these with core principles. Furthermore, investigating new concepts, like organized long-term markets, that seek to meet investor risk and return expectations would allow policymakers to deliver a least-cost, clean, reliable grid — without a heavy regulatory hand.

Eric Gimon is a senior fellow with Energy Innovation Policy & Technology, a nonpartisan energy policy firm that “works with national and regional decision-makers to develop policies that will manage the grid’s transition to a cleaner, lower-carbon resource mix.” Eric holds a B.S. and M.S. from Stanford University in mathematics and physics, and a Ph.D. in physics from UC Santa Barbara.