How to Unlock the Energy Transition


Executive Summary

The transition to a renewable energy system has become a key prerequisite for countries to secure their industrial and export competitiveness.

Without preparing ahead of time, it has become now impossible to overcome international trade barriers like RE100* and carbon border taxes**, both of which necessitate a supply chain heavily reliant on renewable energy. Acknowledging that energy transition is a direct means to strengthen competitiveness in the global market, countries are expediting their journey towards renewable energy. Throughout such development, the most pressing task that needs to be addressed is securing the flexibility of the power system which could compensate for the variability and intermittency of renewable energy. This is where the indispensability of flexibility resources comes into play.

* RE100: a declaration to procure 100% of the power required for business activities in renewables such as solar or wind power by 2050

** Carbon border tax: a form of trade tariff imposed on a product based on the carbon emissions that took place in the manufacturing process, when a country with stringent carbon emission regulations imports that product from another country with lax regulations

In the conventional fossil fuel-centered power system, large-scale and centralized generation like combined cycle power plants (gas power) used to assume the roles of flexibility resources. However, the increase in renewable energy penetration rate and the subsequently growing complexity of the power grid stressed the importance of immediate responses. There exists a need for new types of flexibility resources - it has become inevitable to expand the use of new flexibility resources including ESS (Energy Storage System), DR(Demand Response) and VPPs (Virtual Power Plants), whose small-scale and distributed structure effectively compensates for the variable and intermittent nature of renewables.

However, the stark reality is that the institutional foundation for activating new flexibility resources in Korea lags far behind the required levels. Consequently, there has been a growing number of instances where renewable outputs are curtailed due to the system's failure to promptly secure the necessary flexibility resources essential for building a structure conducive to renewables. The 10th Basic Plan for Electricity Supply and Demand, citing the lack of ‘feasibility’ in integrating excessive renewable energy to the power grid given the current situation, has dropped the 2030 renewable generation share by 8.6%p compared to the increased NDC.

Against this backdrop, this report aims to analyze the root causes that hinder the activation of new flexibility resources, the crucial key to South Korea’s energy transition, and propose policy improvements.

Cause 1. Fossil fuel-centered power market that face challenges in accurately assessing the values of new flexibility resources

Unlike gas generation, new flexibility resources respond organically and instantaneously to the variability and intermittency of renewable energy. In addition, they are well-suited to the current era where small-scale and distributed renewables have positioned themselves as a major power source. Therefore, their values should be judged differently from the conventional schemes. However, the current power market system focused on large-scale and centralized fossil fuel generation makes it challenging to appropriately identify the value of new flexibility resources and provide compensations accordingly.

Fossil fuel-centered power market can be characterized by two traits: the cost-plus markup guarantee scheme and the reflection of variable costs (Cost Based Pool). Such characteristics stood valid in the past when the share of renewables remained at a low level, and when conventional large-scale and centralized fossil fuel power plants covered most of the generation volume. Since the only available flexibility option was the large-scale and centralized gas power, it was sufficient to compensate based on the cost-plus markup and variable costs (fuel costs) to determine the market price, rather than identifying the exact value.

As a result, fossil fuel generation was guaranteed a certain level of profit under the cost-plus markup guarantee scheme designed to align with such values and characteristics. What’s more, it could join the Cost Based Pool market and receive not only the variable costs but also subsidy-like settlements like CP to remain economically viable.

Meanwhile, the value of new flexibility resources is not accurately evaluated in the fossil fuel-centered power system - the reality is, the various benefits they provide are not properly compensated for. A representative case in point is the payment schemes for generation capacity and ancillary services.

Despite providing capacity in a new way unlike gas generation, new flexibility resources are currently not eligible to receive CP settlements. Payments for ancillary services also fails to reflect the nature of these resources, as the technical characteristics that enable the efficient provision of various services are not considered. In some cases, the payment option itself is excluded, which leads to insufficient economic incentives. It is clear that the current power market system is unable to accurately recognize the value of new flexibility resources and provide corresponding compensation.

Meanwhile, it has been widely recognized overseas that the most critical factor in the drive towards carbon neutrality and energy transition is new flexibility resources. Countries around the world are proactively searching for various support measures, including mandating their use or restructuring the power market system to ensure their economic viability.


Cause 2. Absence of a multi-layered power market (real-time market and ancillary service markets)

Another major obstacle to activating new flexibility resources is the absence of a multi-layered market, or a diversely faceted market capable of sending out appropriate price signals to new flexibility resources. 

In the current South Korean electricity market, only the day-ahead (spot) market exists. Such a singular system is unable to provide economic incentives to new flexibility resources that offer various services by different means. This fragmented approach to the power market inevitably fails to ensure the efficiency of market and grid operation well-suited for the era where renewables take a central role. 

As new flexibility resources offer multiple values, the market should likewise possess a multi-layered structure to provide price signals. Examples include a real-time market where these resources’ values are efficiently reflected, as well as a market that compensates for various ancillary services at market prices. 

From February 2024, South Korean power authorities plan to newly establish a real-time and an ancillary services market by running a pilot project in Jeju aimed at enhancing the power market. This is expected to act as a catalyst to sophisticate the market, which used to be fragmented at best in the past, and propel the transition into a renewable-based power system. However, it is critical to thoroughly assess the practical feasibility of activating renewable energy and new flexibility resources through this project. Renewables and new flexibility resources are bound to be compensated less than their risk levels because it is difficult to accurately predict the impact of risks like curtailment, and the value assessment and payment methods are unclear and unfair. As the pilot project will also be expanded to the mainland grid, the value assessment of the overall power market and the corresponding reform of the payment scheme should be urgently carried out. 

Building on the results of the above analysis, policy recommendation directions are suggested as follows:

Firstly, the current large-scale, centralized, and fossil fuel-based power market should be shifted to one dependent on small-scale and distributed renewable energy sources and new flexibility resources. 

To this end, it is imperative to abolish the cost-plus markup guarantee scheme and revise the market system to reflect the prices, not the variable costs, to limit the compensation to fossil fuel power generation to realistic levels. In parallel, the calculation standards for CP and ancillary services should be normalized to accurately reflect the values provided by new flexibility resources, thereby improving their economic viability. 

Secondly, a multi-layered structure involving real-time and ancillary services markets should be established to enhance the power market soundness. 

Moving away from the currently fragmented structure which only entails the day-ahead market, various other types (real-time, ancillary services, and intraday markets) should be available to incentivize the influx of various new flexibility resources. As a result, new flexibility resources will be properly compensated for their services based on the market mechanism and increase their profitability. 

However, it is worth noting that the market prices should thoroughly consider emissions intensity, environmental costs, carbon costs, and criteria for aged generation facilities, to refrain from an ironically distorted outcome where a multi-layered market structure ends up guaranteeing profits for thermal power generation. 

Moreover, the roles of DSOs (Distribution System Operators) should be strengthened to enable a more efficient operation of a power system centered around small-scale and distributed renewable energy and new flexibility resources after such policy improvements.

Share this Research