About the "missing money" problem

Solving the Renewable Energy Puzzle—Flexibility, Storage, and the Missing Money Problem

The energy transition is in full swing, with renewable energy sources like wind and solar reshaping our power systems. But this shift isn’t without its puzzles. One of the thorniest issues? Flexibility—ensuring the lights stay on even when the wind isn’t blowing or the sun isn’t shining. Flexibility is critical to handling renewable intermittency, and it’s tied directly to the growing need for backup solutions. But here’s where things get tricky: the economics of flexibility often don’t add up, creating what’s famously known as the missing money problem.

This blog unpacks the paradox, explores the role of storage technologies, and discusses what it will take to create a low-carbon, reliable energy system.

The Flexibility Conundrum: Backup When You Need It, But at What Cost?

Renewables like wind and solar generate electricity intermittently, meaning their output depends on the weather. This creates periods of surplus power (when generation exceeds demand) and shortages (when generation falls short). Addressing these fluctuations requires flexibility, which can come from various sources: gas turbines, interconnections, demand response, and storage technologies.

For years, gas turbines have been the go-to solution. They’re efficient at ramping up quickly to meet demand spikes, but there’s a catch: as renewables take up more of the market share, these turbines are used less frequently. This pushes their load factors down, making them increasingly uneconomical to operate. When plants are hardly ever needed, their levelized cost of electricity (LCOE) soars.

And yet, we can’t do without them—these backup plants are vital during “dunkelflaute” events (prolonged periods of low wind and solar output). The result? A classic market failure: the missing money problem. Operators aren’t incentivized to invest in rarely used but critically important plants because they can’t make their money back.

The Missing Money Problem: Why Flexibility Needs a New Financial Model

The missing money problem boils down to misaligned incentives. Electricity markets are typically designed to pay for energy delivered, not capacity held in reserve. With no mechanism to reward backup availability, investors avoid building plants they can’t profitably operate.

Several economic fixes have been proposed and implemented worldwide to address this:

1. Capacity Markets (France): These markets pay operators for maintaining capacity, ensuring backup resources are available even if they aren’t frequently used.
   
   

2. Strategic Reserves (Germany): Here, plants are kept out of the market but ready to operate during emergencies. It’s a safety net approach that guarantees supply without distorting market dynamics.
   
   

3. Reliability Options: These are financial instruments that pay plants to be available when needed, effectively hedging against price spikes.
   
   

Each solution has its trade-offs, but they all aim to ensure that flexibility is adequately valued in modern electricity systems.

Enter Storage: A New Flexibility Frontier

While gas turbines have historically provided flexibility, new technologies are stepping in to share the load. Storage solutions, particularly Battery Energy Storage Systems (BESS) and Underground Hydrogen Storage (UHS), are increasingly important in balancing the grid.

BESS: Short-Term Flexibility

Batteries excel at rapid discharge over short periods. Think of them as the sprinters of the energy world—perfect for addressing daily fluctuations, such as solar power drops at sunset. As battery costs continue to fall, their deployment is skyrocketing.

UHS: Long-Term Reliability

Underground hydrogen storage, on the other hand, is designed for the long haul. It’s the marathon runner—ideal for seasonal storage and critical during extended shortages. Germany, with its vast salt caverns, has immense potential for UHS, which could play a central role in its decarbonised energy system by 2035.

Substitution or Synergy? BESS and UHS in Action

My recent study (written with Camille Megy from CentraleSupelec) dives into the interplay between BESS and UHS in a 100% renewable German electricity system. Using a stochastic programming model, we explored how these two technologies substitute for each other and what this means for investment and system design.

Key Findings:

1. Asymmetric Substitution: While UHS can effectively replace BESS in many scenarios, the reverse is far less true. UHS is essential for long-term system stability, making it akin to a necessity good in economic terms.
   
   

2. Profit Challenges for UHS: Much like gas turbines, UHS faces the missing money problem. Its profits are highly volatile, and without strong policy support, private investment is unlikely to reach socially optimal levels.
   
   

3. BESS as a Market Favourite: Batteries are already widely deployed due to their declining costs and more frequent utilisation. Unlike UHS, they don’t depend as heavily on public subsidies to be financially viable.
   
   

The Bigger Picture: Solutions for a Reliable Low-Carbon Grid

The path forward for flexibility isn’t just about choosing the right technologies—it’s about designing markets and policies that ensure these technologies thrive. Here’s what needs to happen:

1. Create Strong Incentives for Long-Term Storage: UHS operators need revenue certainty to invest in large-scale projects. Mechanisms like capacity markets or reliability options could bridge the gap.
   
   

2. Promote Technological Synergies: UHS and BESS aren’t competitors—they’re complementary. Policymakers should encourage a mix of short- and long-term storage to meet various flexibility needs.
   
   

3. Expand Grid Infrastructure: Interconnections between countries can reduce the need for domestic flexibility, but they require significant investment and coordination.
   
   

4. Support Innovation: Technologies like vehicle-to-grid (V2G) systems and advanced demand response could provide new sources of flexibility at a lower cost.
   
   

Final Thoughts: Flexibility as the Backbone of the Energy Transition

The energy transition is a complex puzzle, and flexibility is the piece that holds it all together. Whether it’s batteries smoothing out daily peaks or hydrogen storage powering through seasonal shortages, flexibility solutions are essential for a reliable, low-carbon future.

But making these solutions viable requires a rethink of market design. From solving the missing money problem to incentivising long-term storage, policymakers have a critical role to play. With the right tools and strategies, we can build an energy system that’s not just cleaner but smarter, too.