Why the Sustainable Provision of Low-Carbon Electricity Needs Hybrid Markets: The Conceptual Basics

Deep decarbonization of energy systems poses considerable challenges to electricitymarkets and there is a growing consensus that an energy-only market design based onshort-term marginal cost pricing cannot deliver the adequate levels of investment and longterm coordination across actors and sectors. Based on the vivid example provided by theevolution and adaptations of the European electricity market design, this paper firstdiscusses several shortcomings of energy-only markets and explains how ad-hoc policiesthat intend to address these limits also have limits of their own, notably due to a lack ofsystemwide coordination. Second, it characterizes how deep decarbonization exacerbatesthese issues, raises short- and long-term uncertainty in energy-only markets, and howprivate investment in capital-intensive low-carbon technologies tends to fall short of thesocial optimum. Ambitious emission reduction targets (e.g. net zero by 2050) thus requirean evolution of market design, which we argue should shift towards hybrid market designregimes. The key feature of a hybrid design is the separation of long-term investmentdecisions from short-term operations through a careful and balanced use of competitiveand centralized design elements to coordinate and de-risk investment. Finally, a conceptualanalysis of the evolution of different market designs in a historical perspective shows howhybrid markets constitute the contemporary form of long-run marginal cost pricing that isappropriate for meeting deep decarbonization objectives with radically reduceduncertainty and at least private and social costs.