regions (coupling of markets) and high spatial resolution of price signals, i.e. prices differ from place to place.

Modularity – Local supply may exceed demand and lead to flows from lowto high-voltage levels. System operation needs to better co-ordinate the interface between voltage levels and low-voltage grids need to be more actively managed. Where markets are in place, this implies a greater significance for dynamic price formation in low-voltage grids and the need for close integration with wholesale markets.

Non-synchronous technology – System operation needs to explicitly manage the possibility of new constraints, such as low levels of synchronous inertia. VRE power plants can contribute to managing such issues by providing system services. Where markets are in place, this implies a greater need for system service markets, i.e. prices for products other than bulk power.

Where the policy, market and economic frameworks contradict the above principles, integration of VRE will be more costly and result in lower system reliability. In turn, adoption of these principles can enhance power system efficiency and reliability, even in the absence of VRE. However, substantial effort may be required to adjust legacy designs to more advanced practices. The following sections discuss how the principles can be implemented by means of enhanced power market design, renewable energy policies and system planning.

Wholesale market design

This section provides further detail on how wholesale markets can facilitate power system transformation. The section starts with an introduction to the general setup of wholesale power markets. It then considers international experiences in five areas that are particularly relevant to the current Chinese context: economic dispatch, trade across larger areas, use of system services and medium-term flexibility, procurement of clean generation options, and inclusion of externalities.

General setup

Short-term markets (minutes to hours)

Short-term markets are the foundation of all market-based electricity systems and have been proven to be a valid approach to cost-effective integration of high shares of VRE.29 In most cases they consist of two main markets: the day-ahead market and the real-time market (Figure 17). In the day-ahead market, participants bid for energy and the market clears and sets hourly prices for each hour of the next day. Generating units are committed accordingly. Then, during the day, adjustments have to be made to balance supply and demand, which are continuously updated. This is done either by system operators or by generators. In Europe, participants can also exchange electricity blocks on an intraday market platform before system operators set balancing energy prices that clear the balancing (or real-time) market. In North America, system operators calculate real-time prices in a five-minute market. System operators also procure a number of ancillary services, including operating reserves, to instantaneously restore frequency.

In addition to these short-term markets, mediumand long-term markets enable trading of electricity and forward capacity development, in advance of the day-ahead timeframe. While

they play a key role in investment decisions (see following sections, Figure 17), it should be remembered that the underlying product of all these markets is the energy traded on shortterm markets.

There is no standard design for electricity markets. Broadly, however, existing short-term markets fall into two categories depending on the degree of geographical and temporal resolution of electricity prices (IEA, 2016a):

Low-resolution market designs have been implemented in Europe, where the primary objective was to enable cross-border trade in electricity. Each country had relatively little internal network congestion and a single price by country was considered sufficient. Within each price zone, power exchanges, not system operators, calculate prices as if congestion and network constraints did not exist. System operators handle congestion by redispatching power plants. The primary market is the day-ahead market. Participation is not mandatory.

The balancing/real-time market is a residual market designed to give market participants the incentive to balance generation and load rather than to reflect the marginal cost of the system.

High-resolution market designs seek to provide an accurate economic representation of the physical reality and operation of power systems. These have become more common in parts of North America, for example in Texas (Alaywan, Wu and Papalexopoulos, 2004). To that end, system operators directly manage the market platform using sophisticated software to perform security-constrained economic dispatch (SCED).

The primary market is the real-time market. System operators calculate the locational marginal price for thousands of nodes in order to reflect real-time congestion on the network (Schweppe et al., 1988; Hogan, 1992 and 1999). In order to better reflect economically (in prices) the flexibility needed to accommodate renewables, the time resolution has recently been increased to five minutes in several markets. Day-ahead market prices reflect the best forecast of real-time electricity prices.

High-resolution market design constitutes the benchmark for short-term markets and can reduce overall costs of operating power markets (Green, 2008; Neuhoff and Boyd, 2011). Market design with a high geographic and temporal resolution is better suited to integrating increasing shares of VRE. Existing high-resolution market designs can be further improved if they become more transparent during the intraday time frame, to facilitate the adjustment of power schedules to improving wind and solar forecasts.

Conversely, the geographical resolution of low-resolution markets has to be improved to contribute to the efficient operation of a more diverse set of power plants. However, the contrast between highand low-resolution market designs reflects the difference in information provided to the market about local and general scarcities in the system. Indeed, the laws of physics are the same everywhere, and even in low-resolution designs, system operators use centralised market platforms with location-specific information to manage congestion and call the power plants needed to balance generation and load in real time. Increasing the transparency of short-term balancing prices by location will become more important with high shares of renewables and would ensure a convergence of market designs (IEA, 2016a).