The Coordination Problem: A key challenge for Smart Grids

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The integration of renewable electricity supply (RES) into the electricity system requires an adaptation of the existing roles in the energy sector. Among other things, two developments are currently taking place.

The two primary challenges on the distribution grid level

First, electricity generation based on RES is becoming decentralized. Here, decentralization refers to the local distribution of small electricity power plants (e.g. small-scale photovoltaic power plants) as well as the decentralization of ownership of these generation assets (e.g. private households installing photovoltaic power plants on the roof tops of their houses). These decentralization trends challenge the established business models of the incumbents, which are based on the centralized power generation business from conventional power plants (see this post for details about this).

The second current development is the increasing investment requirement for network operators. This investment requirement is primarily driven by the increasing feed-in from RES on the distribution grid level, which requires an increase of grid capacity. In Germany, the current estimates are that investments on the distribution grid level for RES integration could add up to 49 billion € until 2032, if the federal governments’ goals for RES diffusion shall be met (see (dena, 2012) and (E-Bridge et al. , 2014)). 70% of these investments will already be required until 2022 (E-Bridge et al. , 2014). These costs will have to be borne by the consumers, as the network investments are financed via network charges.

The overall costs of the grid integration of RES will be high, which leads to the question how these costs can be reduced to a minimum. At this point, industry and politics are standing at a crossroad where it needs to be defined whether traditional network expansion or new approaches are more appropriate to integrate RES into the networks at the lowest costs.

Smart Grids – one approach to reduce the costs of the energy transition

Besides traditional network expansion, there are other methods to integrate RES into the distribution grid level, potentially at lower costs. Most prominently, the application of smart technologies (e.g. smart local power transformers) offers the potential to reduce the investment costs for RES integration. The application of smart technologies to the distribution networks is summarized under the headline of smart grids. The idea of the smart grid concept has first been described by the European Technology Platform for Electricity Networks of the Future (ETP SmartGrids) of the European Commission in (ETPSG, 2010):

”A Smart Grid is an electricity network that can intelligently integrate the actions of all users connected to it - generators, consumers and those that do both - in order to efficiently deliver sustainable, economic and secure electricity supplies. A Smart Grid employs innovative products and services together with intelligent monitoring, control, communication, and self-healing technologies [...].”

For Germany, the estimates are that smart grid applications can help to reduce the costs of RES integration by more than 20% (E-Bridge et al. , 2014) until 2032.

The existing studies about the costs of the energy transition and the potential of smart grids to reduce these costs focus on technical aspects only. However, there are other efficiency potentials that we can exploit with smart grids. In the following, we will focus on one specific issue: The increasing costs resulting from the coordination problem on the distribution grid level.

Background: The electricity supply chain

The electricity supply chain consists of four main parts: generation, distribution, trans- mission and retail. In most countries the generation sector is dominated by central power plants (e.g. nuclear, fossil). Although these conventional technologies still provide the largest amounts in generation today, RES has gained large shares (more than 30% of total electricity production in Germany in 2015) within the last two decades. In most countries the RES is physically connected to the distribution grid level. The distribution grids connect the smaller electricity generators and most consumers (e.g. households and commercial consumers) to the electricity system (distribution networks work with 110 kV or less). The distribution networks are connected to the transmission grids (220 kV and above), which transport electricity over larger distances. Furthermore, the large conventional power plants (hard coal, lignite, gas and nuclear) are connected to the transmission grid in most cases as well. Retail consists of the service providers who sell electricity to the costumers.

The liberalization process in Europe

Within the last decades this supply chain was primarily shaped by the liberalization process (Joskow, 1996). Before liberalization, a hierarchical and integrated system existed in the electricity sector. Utilities were active in all steps of the supply chain with one and the same company. However, Joskow & Schmalensee (1983) pointed out that the introduction of competition in generation could increase the overall efficiency of the electricity sector. To exploit these efficiency potentials, the European Commission introduced a liberalization process, which developed in three steps (1996, 2003 and 2007). Today, network unbundling is the norm: unbundling describes the separation of the electricity networks (natural monopolies) from the competitive parts of the supply chain (namely generation and retail). This means that the unbundled networks are owned and operated by (independent) companies that are not active in generation or retail. Vice versa, generation or retail companies do not own the networks. While the networks are regulated, generation and retail are liberalized, i.e. there exist competitive markets for generation and retail (for more information see Brunekreeft et al. (2016))

The coordination problem

In the given context, coordination describes the exchange of information within the electricity supply chain. Before liberalization this coordination was a hierarchical process, i.e. coordination took place within a utility that operated departments for retail, the networks and generation within one company. After liberalization, the formerly integrated departments of the utilities were separated into different companies.  Joskow & Schmalensee (1983) already stressed that the unbundling of the networks, i.e. the separation of the different steps within the supply chain, will require complex coordination mechanisms (i.e. contractual relations) to substitute the previously internal planning processes of integrated utilities. Market-based coordination mechanisms could substitute the formerly integrated coordination process, potentially even at similar transaction costs. However, today the coordination between the network and the rest of the supply chain is weak. If at all, then this coordination is currently based on network charges, which have been criticized to be imperfect (Brunekreeft, 2015).

Coordination becomes especially relevant at the intersection between the networks and the electricity generation market. Here, a coordination problem evolves due to missing information exchange between the generation companies and network operators (see Brunekreeft et al. (2016) for details). The result of the missing information exchange and the weak coordination mechanisms is an increase in costs and a decrease in efficiency, especially on the distribution grid level (Niesten, 2010).

How distributed generation increases the coordination problem

Although the coordination problem has originally been a consequence of the liberalization process, its relevance increases with the diffusion of distributed generation based on RES as the number of parties that need to be coordinated within the network increases. To better understand this problem let us take a look at what happens with the increasing diffusion of distributed generation (DG) from renewables on the distribution grid level.

Consider the case of an unbundled distribution system operator (DSO) and a generation company that wants to invest into distributed generation (DG). The DSO could implement locally differentiated network charges to give incentives to the investor to install the DG at a specific location where the installation of DG would not require investments into the network. However, this can only result in efficient outcomes if the network charges reflect all costs related to the installation of DG. Brunekreeft & Ehlers (2006) argue that shallow network charges, which are the most common model in Europe, do not reflect all these external effects from DG investments on the electricity network. Therefore, coordination based on shallow charges will result in an inefficient investment into DG.

Coordination is flawed between generation and network companies in further respects as well. While investment into DG might quite often require investments into networks, the investor in DG does not need to consider the DSO’s plan for network expansion. Here, the missing exchange of information between DG and the network creates a coordination problem. More recently Niesten (2010) has stressed that the coordination problem in the Netherlands already slows down the development of DG, which supports the argument raised by Brunekreeft & Ehlers (2006). With an increasing share of RES the coordination problem gains relevance in the current discussion.

In Germany it is currently discussed to introduce a mechanism to reduce the costs of the missing coordination between the network and distributed generation. The idea is to allow the network operators to curtail 3% of annual electricity production of the connected DG. The calculations of E-Bridge et al. (2014) reveal a potential to reduce the network expansion costs by 30% when the curtailment approach is applied. The Federal Government introduced a rule to allow the curtailment by the DSO within 2016. The necessity of the curtailment rule delivers proof for the existence of the coordination problem in Germany.

Two examples why smart grids require more coordination

So far, the discussions about the coordination problem mainly focused on DG and the resulting network expansion costs. Presumably, coordination will become more complex with the introduction of smart grids. Complexity will be driven by at least two effects.

First, the number of stakeholders in the electricity system is going to increase. These actors need to be coordinated to balance demand and supply. New stakeholders can evolve on the production side, as more DG is owned by small investors (even by households) or on the consumption side, where more consumers actively participate in the electricity system (e.g. based on demand-response-mechanisms).

Second, information and data in smart grids need to be exchanged at a higher quantity as well as with a higher resolution. While grid operation might not need every data set per second of every costumer connected to the grid, services on the market might have an interest in this detailed data and costumers might demand these services. These new services are likely to have direct effects on the operation of the distribution grid. For example, demand-response-mechanisms aim at an adaptation of consumers’ demand according to price signals. So far, these price signals change over the day, but they do not take into account the balance of load and production on the distribution grid level. Today, the effect of these new services might be marginal as most of the instruments are only in the pilot phase. Nevertheless, a growing market for these services might significantly increase the coordination problem between the DSO and network users.

The discussed solutions to the coordination problem on the distribution grid level

Different approaches to tackle the coordination problem are currently discussed, e.g. regional electricity markets (for more information on the German debate we recommend this German study by AgoraEnergiewende), data management models (see this post and this post for details) and broader platform concepts (as we introduced in this post). While some US states like New York and California are aiming at regional platform solutions, most European states are currently focusing on establishing data exchange systems to increase coordination. Furthermore, projects in Germany like enera (www.eneraproject.com) try to show the potential of regional flexibility markets to increase coordination. So far, it has not turned out whether one of the above or a combination of the different approaches will be applied to increase coordination of the distribution grid.

What do you think?

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