“New Market Design is needed”: lessons to learn from renewable energy regulation in California and Germany

09.07.2019 - Important lessons can be learned from the two global frontrunners in the energy transition, Germany and California, a new report shows. Being the 4th biggest and 5th biggest economies worldwide, both jurisdictions draw more than 30 percent of their electricity from wind and solar and biomass, both have ambitious renewables targets of 80 and 100 percent by mid-century. An international team of scientists from Germany and the US now analyzed Californian and German policy pathways to draw conclusions for the way ahead. They find that market and renewable policy design adjustments in both jurisdictions to integrate the first 30 percent were small compared to the adjustments needed to integrate the second 30 percent. Importantly, strengthening CO2-pricing and policies to foster electrification must be an integral part of this.
“New Market Design is needed”: lessons to learn from renewable energy regulation in California and Germany
Wind energy in California. Photo: istock/SumikoPhoto

“Both jurisdictions are trying to go where electricity systems have not gone before,” said the research project’s leader Michael Pahle from the Potsdam Institute for Climate Impact Research (PIK). This is why policy and market design in California and Germany resemble a ping-pong of policy experimentation and problem discovery. A common theme for both is that as the share of renewable energy increased, policy costs have become higher and their distributional impacts more worrysome.  In response policy makers in Germany and California have become more and more concerned with fixing regulatory flaws that provide inefficient or inequitable incentives for renewable investment.

Lessons learned and directions for the path ahead

“This underlines that more of the same won’t work and new market and policy design is needed”, says Pahle. This is one of the main findings of the report conducted as part of the AHEAD project funded by Stiftung Mercator Foundation and ClimateWorks. Authors include Dallas Burtraw from US think tank Resources for the Future, Jim Bushnell from the University of California Davis, and Christian Gambardella from PIK.

Special consideration was given to identifying issues where both could learn from each other for the way forward. A major concern in Germany is the misalignment of renewable capacity and transmission capacity growth, due to which grid bottlenecks are becoming a significant cost driver of the energy transition. By contrast, power market regulation in California positioned the state well to accommodate the rapid growth of renewable energy. Particularly the introduction of locational marginal pricing, where electricity prices differ at different locations in the power grid, provide proper signals to invest in capacity where it is mostly needed. “Given that costs from grid congestions keep rising, German decision makers might have to reconsider their commitment to the uniform price zone and adopt California-style zonal pricing”, says Gambardella.

Another issue where Germany could follow in California’s footsteps is the envisaged role for carbon pricing to reach the 2030 climate targets. “It is still an open question how much emission reductions could be achieved even with relatively high prices,” Burtraw explains. “Yet California is pushing harder to find out, already having economy-wide carbon pricing with an increasing price collar in place. While Germany is considering similar action, it might look to California as a potential role model to follow suit.”

Moreover, with regard to future policy and market design, the report finds surprising overlap of the challenges lying ahead for policy makers in both jurisdictions: Electricity tariffs need to be redesigned to guarantee fixed cost recovery while exposing consumers to the benefits and costs of volatile power prices from renewable energy. Energy taxes need to be reformed such that existing distortions between fuel prices in the power, transportation and heating sector are reduced to finally achieve a sufficient level of electrification. Pahle concludes: “It is clear that Germany and California are in the same race, and they better run fast in face of their ambitious 2030 emission targets to effectively limit climate risks.”

Weblink to the report "The response of market and policy design to increasing shares of renewables in California and Germany: Lessons learned and directions for the path ahead" (pdf):

Weblink to the AHEAD project page: