The economics of flexibility service contracting in local energy markets: A review

Electricity networks require reinforcing to accommodate increasing penetration of renewables and increasing electrification of heating and mobility. The nature of these reinforcements depends on the scale and depth of demand reductions and flexibility services available to solve constraints. Local energy markets are posited as a means to capture, aggregate, and trade flexibility services in network-constrained areas. Using insights from transaction cost economics, this review adapts a theoretical model to analyse the contractual arrangements underpinning both local energy markets and the delivery of flexibility services therein, and the end-to-end process of flexibility service delivery. By facilitating the identification, analysis, and comparison of the relative magnitude of associated transaction and production cost variables, it helps identify factors which determine their viability. This model is tested on Great Britain's Local Energy Oxfordshire project (Project LEO) which sought to establish the potential for flexibility service provision to support the transition to a renewables-based electricity system by developing a proof-of-concept local energy market. It reveals transaction costs which significantly outweigh contract revenues at this stage of market development. Standardisation and regulation lower transaction costs in the establishment of local energy markets, while automation and aggregation lower transaction costs and increase contract revenues of flexibility service delivery. Support needs to be appropriately targeted to lower these costs vis-à-vis network reinforcements, and the overall costs of transitioning to net zero.