different resources contribute to system flexibility. Additionally, competing uses such as irrigation, land use and environmental conservation should be accounted for in long-term planning.

Require flexibility in new assets through regulation and network codes: Requiring the submission of non-wire alternative plans, specific flexibility capabilities for new builds, the installation of monitoring equipment and the inclusion of flexibility in interconnection contracts will help embed flexibility in system transformation.

Enable flexibility investments through innovative regulation: Reviewing cost recovery methodologies, introducing requirements for non-wire alternative proposals in regulated infrastructure expansion plans and partial appropriation of additional savings are some of the options available to TSOs and DSOs to deploy DER.

Encourage and co-ordinate the reallocation of institutional roles: Regardless of the decision to separate system operation from transmission, or to enable distribution system operation, policy makers should facilitate dialogue between various system actors on a level playing field. Depending on context, this may range from providing communication platforms to reviewing the regulated monopolies’ organisational and budgetary structures.

Improve visibility and bidirectional information sharing: The shift towards a decentralised power system means that at higher levels of distributed generation, power may start flowing back to the transmission grids. Having an overview of installed DER and expected generation may help system operators reduce costs of redispatch and network reconfiguration.

Transition mechanisms to facilitate system reforms

Most transitions from a centrally planned power system to one relying on market mechanisms require consideration of how the old system will be phased out and the new one implemented. A smooth transition requires special instruments and mechanisms. Although there are no two examples with the same transition instruments (because they respond to each country’s power sector circumstances), a number of examples that provide interesting insights are given below.

Mexico’s legacy contracts for the regulated supplier

Mexico is a good example of transition from a predominantly vertically integrated utility to a competitive wholesale market. Prior to the reform the country’s generation was managed through three main legal regimes (as shown in Figure 24 below):

plants owned and operated by Comisión Federal de Electricidad (CFE), the vertically integrated utility

independent power producers (IPPs) selling power exclusively to CFE

an additional regime in place for consumers on self-supply, which allowed for wheeling between different points of the transmission grid.

For thermal plants, the contracts were structured as “call” options, giving CFE Retail the right to purchase CFE-vested output when the contract price was below the wholesale price. This reinforced the principle of end-consumer protection.

A number of provisions were included to ensure shortand medium-term efficiency:

Contracted prices reduce the generator’s incentive to strategically curtail output.

Contracted prices incentivise generators to further optimise their plants, as they are allowed to keep output beyond the contractual quantity or higher margins resulting from efficiency gains.

For thermal generators, the contract does not provide any incentive to keep inefficient power generation units, as the contract allows them to replace their units for ones that are more efficient and keep the extra margins.

CFE Retail is obliged to purchase all the output from renewable technologies. However, VRE plants are free to sell any excess energy output resulting from repowering to any other market participant.44

Lastly, one of the key features to ensure a smooth transition was providing a gradual phase-out of vesting contracts to competitive procurement. For this reason, vested contract duration was limited to the year that net present value was maximised, thus phasing out older inefficient plants first. Additionally CFE Retail was now able to fully or partially shed any contracted overcapacity, starting with the oldest CFE-vesting plants in the portfolio, meaning that there is no demand risk for the retailer.

IPP-vesting contracts: The key feature in these was to respect the initial contractual terms and provide revenue certainty for these generators. As part of CFE’s unbundling, a special subsidiary was created to handle their contracts and represent these plants in the market. The main advantage of this was not to create an offtaker risk. The new subsidiary has a similar legal status to its parent company, CFE Holding, a state-owned enterprise with the implicit backing of the Mexican government. This means it cannot go bankrupt except in the case of an explicit government decision.

As most of these IPP contracts concerned combined cycling plants, one particular feature was addressed with the new contracts. Contracted combined-cycle gas turbine IPPs rely on a synthetic output offer curve that covers three feasible discrete output levels. This created issues on both sides: generators were at a disadvantage if they were dispatched at a point where the stylised offer curve fell below actual production costs or at an infeasible output level. CFE, by contrast, could face a loss in the wholesale market if it was purchasing output at a price level above the actual production costs. The new market rules allow for generation compensation that reflects actual production costs.

Under this transition mechanism, any increase in contracted capacity in the future must be procured by CFE Retail through competitive auction processes. The actual and anticipated gradual decline in capacity under legacy contracts, and their share of maximum demand, can be seen in Figure 25.