Power-to-gas is the future. What should regulators bear in mind?

Key takeaways

  • PTG can avoid spillage of renewable electricity by providing a longer-term storage solution, making use of the existing gas infrastructure.
  • A mathematical model simulating different scenarios enables to study the price effects in the electricity and gas markets due to the deployment of PTG, as well as identifying misaligned incentives by comparing the sector and total welfare optimal installed capacity of PTG and the distribution of welfare across sectors.
  • It is the first model to focus on sector coupling and how it changes the market dynamics.  

The results of a first study funded by the Fluxys Chair were published as a working paper and, applauded by peers, presented at the 42nd International Association for Energy Economics (IAEE) Annual Conference in Montréal and to an equally  discerning audience of gas economists in Paris. Doctoral researcher Martin Roach developed an economic model for power-to-gas (PTG)1 that anticipates the EU and Belgian regulation of sector coupling. “Being one of the first to take into account market dynamics, it provides timely and valuable input to the debate”, says a proud professor Leonardo Meeus

Spillage

“Wind and solar installations tend to generate most power during the day while demand is at its peak in the evenings. Sooner or later, increasing the share of renewables in electricity generation will lead to spillage due to a mismatch in production and demand”, explains Leonardo. “Some countries, like Germany, already have to deal with it. Obviously, the surplus electricity could be stored in batteries, but these are still relatively expensive and especially suitable for short-term applications. Instead of investing in new batteries, why not make use of the existing gas infrastructure, which currently provides more storage capacity and is suitable for longer-term storage, ideal to balance seasonal peaks.”

Is there a shared interest?

“PTG is one of the emerging technologies in the sector coupling paradigm”, Martin nods. “However, will it break through? It affects both electricity and gas sectors, but are they equally supportive of this new technology? If its presence has a negative impact on one or the other, investments in PTG may never materialise.” And he adds: “Our study analyses whether in a future with increasing shares of renewable electricity, there is a convergence of interests in deploying PTG. How will PTG impact overall welfare as well as the welfare of the different consumers in the two sectors?”

Optimisation problem

To answer the question, Martin developed an economic equilibrium model simulating the impact of PTG in different scenarios combining PTG investment costs and RES (renewable energy sources) targets. The stylised electricity market is made up of two conventional generators using gas-fired power plants and one renewable generator using wind energy. The gas market is modelled assuming renewable gas supplies from hydrogen injected by PTG and conventional natural gas accessed via long-term contracts. The PTG investor arbitrages between these two markets. RES targets are supposed to be met by the electricity market alone.

The model boils down to a combination of optimisation problems for the different agents involved, i.e. profit-maximising gas and electricity providers, a profit-maximising PTG investor and cost-minimising electricity and gas consumers. Across scenarios, Martin studied the price effects in the electricity and gas markets due to the deployment of PTG, as well as arbitrage revenues for the PTG investor. For each scenario, he compared the sector and total welfare optimal installed capacity of PTG, i.e. the installed capacity that maximises welfare, and distribution of welfare to identify misaligned incentives. A sensitivity analysis identified the impact of various system parameters, allowing the findings to be put into perspective.

It makes sense to cooperate, but …

For Martin the most important conclusions to be drawn from the simulations are the following:

  • PTG deployment levels have an impact on the electricity price, which is determined by inter-fuel arbitrage if sufficient PTG capacity is installed to absorb spillage”, he says. “However, as more capacity is installed, the PTG investor sees its arbitrage revenues increase to reach a peak, after which they erode.”

  • The electricity and gas sectors do have a shared interest in cooperating on PTG because in those scenarios in which PTG is profitable and welfare improving, electricity and gas consumers both benefit from lower prices. “PTG then absorbs spillage, which benefits electricity consumers thanks to a reduction in the RES premium. At the same time, gas consumers benefit from PTG as it offers an alternative gas supply, thereby reducing dependency on long term contracts, which in turn lowers the gas market prices. In sum, there don’t seem to be significant misaligned incentives between these two sectors.”

  • However, there is an issue of misaligned incentives related to the PTG investor: “There are scenarios in which total welfare is maximised, while the PTG investor makes a loss. This would suggest that it makes sense to subsidise PTG in order to increase welfare over and above what you’d achieve in a perfectly competitive market. We’ll need to strike a balance between incentives and support for renewables and PTG”, Martin concludes.

Food for thought and debate

Most previous studies on sector coupling have been analysing the electricity and gas markets separately, focusing more on one or the other. “Using balanced, though stylised, representations of these two markets, our model focusses on the sector coupling and how it changes the market dynamics.” Leonardo stresses that their model is not prescriptive. “It doesn’t tell you what to do but provides input for the regulatory debate on sector coupling, in which all sorts of options will be presented. And our model has the merit of quantifying several of these.” 

Perfect timing

Not only is the model the first of its kind, Leonardo points out it is also most timely. “The Clean Energy for all Europeans Package sets targets for electricity generation from renewable resources, but a similar package for gas is underway. As Martin said, PTG is an emerging technology, but it’s also an emerging business. The question is whether it can be a profitable one or whether it needs to be supported via subsidies and/or grid tariffs. That’s an issue that will certainly be raised when discussing the gas package. Some have also floated the idea of renewable gas targets. Whether or not such targets would be useful will be analysed in a second study. Martin is busy working on it already.”

Front seat

While academic, this study has immediate practical relevance for Fluxys. “They are currently developing an industrial scale PTG project to evaluate the feasibility and economic viability, and to familiarise themselves with the technology”, says Martin. “Having been at the forefront of the Gas for Climate consortium, a group of seven leading European gas transport companies and two renewable gas industry associations that are committed to achieving net zero greenhouse gas emissions in the EU by 2050, Fluxys now wants to anticipate any upcoming legislation included in the gas package. This study on PTG puts them in the front seat.”

“We are very fortunate that Fluxys recognises the benefit of sound academic research”, Leonardo adds enthusiastically. “And thanks to them we can present our work also on other academic platforms!”

1 Power-to-gas technology enables the storage of excess electricity from renewable resources by converting it to gas. There are different methods, all of which first use the electric energy to produce hydrogen (H2) by water electrolysis. Depending on the method, this H2 is subsequently combined with CO2 to convert it to methane (CH4). H2 and CH4 are either injected into the existing gas grid or stored underground and then used for electric power generation in gas-fired power plants or, in the case of H2, fuel cells.

Sector coupling : the new buzzword
“While sector coupling is all the rage in academia and among regulators, it still means different things to different people”, says Leonardo. “One thing is certain: the power or energy sector should no longer be seen as separate silos – coal, electricity, gas, oil, renewables. Loosely defined, sector coupling aims to connect the power and end-use sectors in order to integrate an increasingly larger share of intermittent renewable resources, which implies interactions between energy and end-use markets as well as between different energy markets, e.g. electric vehicles illustrate how the mobility and electricity markets converge and power-to-gas installations link the electricity and gas markets.” 

Source: The paper “The welfare and price effects of sector coupling with power-to-gas” is published in the working paper series of the European University Institute, Robert Schuman Centre of Advanced Studies, Florence School of Regulation (RSCAS 2019/46). You can also request a copy from the authors.

About the authors
Martin Roach is a doctoral researcher at the Vlerick Energy Centre. Leonardo Meeus is Professor of Nonmarket Strategy and Corporate Affairs at Vlerick Business School and director of the Vlerick Energy Centre.

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