Electricity Markets Need Overhaul to Handle Rising Demand and Renewables: IEA

A new analysis from the International Energy Agency (IEA) concludes that wholesale electricity markets remain broadly effective at ensuring reliable operations but require significant updates to support long-term investment, risk management and the growing complexity of modern power systems.

The report, Electricity Market Design: Building on strengths, addressing gaps, released today, examines the performance of market structures across Europe, the United States, Japan and Australia and identifies reforms needed to maintain secure, affordable and sustainable electricity supply.

According to the IEA, well-functioning electricity markets are a critical tool for balancing supply and demand, coordinating day-to-day operations and signalling when and where new investment is needed. As electricity systems undergo rapid transformation — driven by rising power demand, increased electrification and large growth in variable renewable energy — the agency says effective market design will play an increasingly central role in supporting system reliability and policy objectives.

Short-term markets performing well despite growing system complexity

The report finds that short-term electricity markets, including day-ahead, intraday and real-time markets, have continued to operate effectively even as the systems they manage have become more complex. Across the regions analysed, electricity was supplied securely more than 99.9 per cent of the time over the past five years.

Short-term markets have been successful in maintaining reliable dispatch, enabling efficient scheduling and supporting transparent price formation. They also accommodate a wide range of technologies and participants. In Europe, the IEA notes, the day-ahead market processes more than 400,000 bids every hour, submitted by thousands of registered market actors — one of the most detailed and high-volume power-market operations in the world.

Despite these strengths, the report says short-term markets must evolve to keep pace with the rapid introduction of new technologies and shifting operational patterns. As more distributed energy resources, flexible demand, storage and variable renewables enter the system, market designs will need greater temporal and locational granularity and improved access for smaller or distributed participants. These changes, according to the IEA, will help ensure that price signals better reflect real-time system needs.

Long-term markets lag behind investment needs

While short-term markets remain effective, the report identifies substantial weaknesses in long-term electricity markets. In most regions assessed, liquidity is low and trading volumes are limited. Forward and futures markets see the majority of activity within two years of electricity delivery — far shorter than the time horizons required for financing large capital-intensive energy projects, which often need stable revenue expectations 10 to 30 years into the future.

The lack of long-term market depth reduces the ability of investors and utilities to manage price risk and secure financing for new generation capacity, energy storage, grid infrastructure and electrification projects. The IEA finds that this gap undermines the investment conditions needed to meet future electricity-system demands and achieve long-term policy goals. Market participants, the agency reports, would benefit from reforms aimed at extending contract duration, improving liquidity and widening access to long-term hedging tools.

Complementary mechanisms are important but must be well designed

To compensate for limitations in long-term markets, many jurisdictions have introduced complementary policy mechanisms. These include capacity remuneration schemes, renewable-energy support programmes and other tools designed to advance investment, maintain essential dispatchable capacity and support emissions-reduction goals.

The IEA notes that these mechanisms have become structural components of electricity markets in Europe, parts of the United States, Japan and Australia. They have played an important role in ensuring system adequacy, bringing forward new low-emissions generation and retaining flexible resources that may run less frequently as renewable energy grows but remain necessary for reliability.

However, the report cautions that complementary mechanisms must be carefully designed. In some jurisdictions, design flaws have led to inefficiencies or higher system costs. The IEA stresses that these mechanisms must be coherent with — rather than contradictory to — wholesale market signals to avoid distortions and ensure efficient outcomes.

Holistic market design needed to support the electricity transition

The IEA’s overarching conclusion is that electricity-market design must be treated holistically rather than through piecemeal updates. Because markets now operate alongside major policy instruments, grid constraints, distributed resources, digital technologies and new forms of flexibility, coordinated reforms are needed to maintain investor confidence and support smooth implementation.

The report emphasises three priority areas for reform:

1. Preserving and refining short-term market strengths, particularly by increasing their ability to incorporate variable renewables, distributed resources and flexibility needs.

2. Strengthening long-term market frameworks to provide durable investment signals and accessible risk-management tools.

3. Aligning complementary mechanisms with wholesale-market outcomes to ensure policy goals are met without reducing market efficiency or raising costs unnecessarily.

The IEA also stresses the importance of transparency and predictability in reform processes. Clear and consistent policy frameworks, the agency says, will help build stakeholder confidence and ensure markets can support the rapid transformation now underway in global electricity systems.

Next steps and broader context

The release of this report comes as countries worldwide scale up efforts to decarbonise their electricity systems, electrify transport and heating and expand renewable-energy deployment. The IEA notes that rising power demand, increasing system complexity and high investment needs make strong market design increasingly important.

As electricity becomes the backbone of the energy transition, the report argues, market frameworks must evolve to maintain secure, affordable and sustainable power supplies.