German bidding zone split: Learning from the experience of the Nordics

Bidding zones have supported efficient plant scheduling in the Nordics but less obvious benefits in terms of long-term investment planning. However, extrapolating from these experiences to Germany should be done with care given important differences between the historic Nordic power system and the future German one.

German bidding zone split: Learning from the experience of the Nordics

Dividing the German price zone has gained prominence in German political debate. Interest in the idea is being driven by the regional imbalances between supply and demand that have emerged following, among other things, the successful expansion of renewable energy generation in the north. These regional imbalances, coupled with delayed network reinforcement, have created bottlenecks in the transmission system.

In this context, THEMA prepared a report on behalf Agora Energiewende, setting out the lessons to be learnt from the Nordic electricity markets’ long experience of using smaller, sub-national bidding zones. The report sets out the historical effects of these zones on the power system as a whole and the extent to which past Nordic experience is likely to be indicative of the impacts of such zones in Germany.

One notable benefit of the zones in the Nordics has been improved dispatch efficiency, as grid bottlenecks are directly reflected in the spot market. The use of price zones has also significantly influenced demand flexibility. However, when it comes to providing long-term investment signals, the zones’ influence has been muted. There have, historically, only been small regional price differences and these have consequently had a limited effect on renewable energy investments. The use of smaller zones has also harmed the liquidity of futures markets, limiting market participants’ ability to hedge zonal price risk. To partly address this issue, regional system-price hedging contracts were introduced in the Nordics. However, this instrument is only useful when regional and zonal prices are exposed to similar price risks.

Extrapolating from this experience to anticipate the impacts of a German bidding zone split needs to be done with care as there are several important differences to be borne in mind. For one, a primary goal of the Nordic market design was, and continues to be, ensuring that the physical limits of the transmission network are visible to the market. This supports the economically optimal utilisation of generation capacity and of the Nordics’s extensive hydropower reservoirs. Furthermore, unlike Germany, where price differences between zones are a contentious issue, in the Nordic region, these differences have, until recently, been relatively small. As a result, there was comparatively limited public and political resistance to the original introduction of bidding zones in the Nordics.

When considering the experiences likely to be most relevant to Germany, we conclude that small bidding zones could support short-term dispatch efficiency and demand flexibility in Germany. However, the latter benefit would only be realised if smart meters and spot price retail tariffs are introduced that expose consumers more directly to market prices. In contrast, when it comes to the impacts on long-term investment signals, and on trading and hedging, past Nordic experience is of limited help in predicting future German outcomes. There are simply too many differences that frustrate useful inference from one to the other.

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