New Generators: Policy Instruments for More Efficient Siting

The site at which new wind, solar or gas-fired power plants are built currently depends primarily on land availability and on generation costs at the respective locations. The costs of grid expansion and congestion management, by contrast, are invisible to investors. Several reform proposals aim to change this, most notably the current draft legislation on the so-called “grid package”. A new analysis by EWI shows that several instruments could make site selection more efficient, but mostly at the expense of dispatch efficiency or investment certainty. In the analysis, combinations of grid connection charges and dynamic feed-in limits perform best.

The analysis “Locational Steering of Investments in Electricity Generation: A Comparison of Policy Instruments” by the Institute of Energy Economics at the University of Cologne (EWI) compares seven instruments that are currently under discussion or already implemented: redispatch reservation (Redispatch-Vorbehalt), grid connection charges (Baukostenzuschüsse), flexible connection agreements, spatial steering via a bidding zone split, dynamic grid fees, or remuneration under the EEG and capacity mechanisms. It assesses their effects on efficiency and distribution and discusses possible combinations. The analysis was funded through the “Integrated Electricity Market Design” funding initiative of the Gesellschaft zur Förderung des Energiewirtschaftlichen Instituts an der Universität zu Köln e.V.

All Instruments Have “Side Effects”

None of the instruments examined perfectly steers the siting of investments in generation facilities. A bidding zone split, as well as spatial steering via the EEG or capacity mechanisms, appears relatively efficient at first sight, but would have considerable drawbacks in implementation: high regulatory effort, long implementation times and low spatial granularity. A redispatch reservation, flexible connection agreements and dynamic grid fees, in turn, would tend to worsen dispatch efficiency and investment certainty – drawbacks that could only be partly remedied. With respect to distributional effects, the same pattern emerges across almost all instruments: they tend to burden non-subsidised generators and the state, while consumers would mostly be relieved through lower grid fees.

“Grid costs are an externality in today’s electricity market design. To site new capacity efficiently, these costs have to be internalised in the investment decision. There is, however, no single perfect instrument for this,” says Pia Hoffmann-Willers, Senior Research Associate at EWI, who prepared the analysis together with Jun.-Prof. Dr. Oliver Ruhnau, Hanna Klar, Christoph Mehler and Arne Lilienkamp.

Advantageous Combinations of Instruments

The analysis describes combinations of grid connection charges and dynamic feed-in limits – implemented through a redispatch reservation or flexible connection agreements – as promising. On their own, grid connection charges have the advantage of investment certainty, but they worsen dispatch efficiency because they are levied on the entire connection capacity and thus create an incentive for a static limitation of feed-in. If they were levied only on a firm partial connection capacity and, in addition, optional feed-in with dynamic limits were made possible, both grid congestion and grid expansion costs could be internalised.

“Grid connection charges and feed-in limits complement each other: combined smartly, they can make site-specific costs for grid expansion and congestion visible to generators, without unnecessarily weakening dispatch efficiency or investment certainty,” says Jun.-Prof. Dr. Oliver Ruhnau.