The implications of digitalization on future electricity market design

This insight seeks to conceptualize the interactions between the energy transition and the digital transition in the electricity sector. Overall, the digital transition will lead to a more efficient and flexible electricity sector, but will require careful consideration of its implications for the industry structure and pricing mechanisms. Digital technologies can also enable new energy ecosystems, help innovate business models, and accelerate the energy transition itself.

Based on a transaction cost approach, this piece offers insights in three areas: industry structure, ultimate products, and pricing. The digital transition in the electricity sector will lead to a vertical fragmentation in the value chain, but also to horizontal integration with other sectors such as transport. While digitalization may increase fragmentation and market power in the value chain, it can also create new opportunities for smaller players, and reduce excess capacity. Additionally, new smaller players are expected to enter the market, competing in a modular fashion rather than based on scale. This may lead to competition in some segments, while others may be prone to increased market power. Digitalization can redefine the ultimate products of the electricity sector, launching new ones, but since some segments may have zero marginal costs, this would require a new approach to pricing and packaging.

Digitalization and decarbonization technologies can interact and co-evolve to create new systems that can further transform the energy sector. The insight uses the framework of co-evolution to analyze the potential outcomes of this interaction, and suggest two corollaries. The first corollary discusses how this can lead to the emergence of a transversal or parallel value chain structure. The second focuses on hyper-specialization and non-zero marginal cost pricing, and suggests that the zero marginal cost of renewable energy would require a new mechanism to capture scarcity sources.

This framework can help analyze relevant policy questions such as the consultation on electricity market design in the UK and EU. The framework aligns well with the proposal of a two-market approach that would encourage demand-side flexibility and incentivize firms to create hyper-specialized products.

This insight argues that digitalization has the potential to revolutionize the electricity sector by disrupting its existing industry structure, enabling new products, and ultimately improving overall industry performance. A pertinent question that needs to be addressed in future research is the reverse question: whether there are certain industry structures and legacies in terms of regulation and infrastructure that facilitate or hinder digitalization. As the electricity sector continues to evolve and integrate digital technologies, it is critical to consider how industry structures can either support or impede innovation.

By: Rolando Fuentes , Bassam Fattouh