As the share of variable renewable energy such as solar and wind rises rapidly, ensuring adequate investment in facilities that prevent outages and maintain reliable supply has become more important. Yet, Korea’s wholesale electricity market relies on rigid pricing rules that fail to provide appropriate investment incentives, delaying the expansion of required resources. It is therefore desirable to reform the pricing framework so that market prices reflect demand and supply conditions effectively as signals for investment and system operation.

Ⅰ. Introduction

Over the past two decades, Korea’s electricity market environment has changed substantially. The number of market participants increased from 10 in 2001 to 6,333 in 2023, while electricity demand more than doubled from 257.7 TWh to 546.0 TWh. The share of renewables, particularly solar and wind, grew sharply from 0.04% to 8.5%,amplifying volatility across the power system.

Renewables are projected to grow at a faster pace, providing 18.8% of electricity generation by 2030 and 29.2% by 2038.The shift to high renewable penetration requires assessing whether Korea’s wholesale electricity market, originally designed for limited renewable integration, can still ensure a stable supply. Renewable output fluctuates sharply with weather, and these swings, combined with rigidities in the wholesale market, expose the power system to the risks of reserve shortages and widespread blackouts. This study examines emerging market dynamics under expanding renewables,identifies structural limitations, and proposes policy measures to address them.

Ⅱ. Electricity Market Changes with Renewable Expansion

Solar and wind generation, heavily influenced by environmental conditions, fluctuates substantially by day and hour, amplifying volatility across Korea’s wholesale electricity market. At the same time, more firms and households are bypassing the wholesale market by direct sourcing or self-generating renewable electricity. Consequently, when renewable output is high, such customers purchase less from the wholesale market; when output is low, they purchase more, widening demand volatility in wholesale trading. This structure has markedly increased day-to-day variations in traded volumes (Figure 1).

Higher volatility from expanding renewables manifests as a widening gap between the minimum and maximum trading volumes in the wholesale market (Figure 2). As overall electricity demand rises, monthly maximum trading volumes continue to grow. In contrast, during periods of high solar and wind output, wholesale market demand falls as firms and households sourcing electricity in part from renewables reduce their market purchases, potentially leading to a structural decline in monthly minimum trading volumes.

The wholesale electricity market factors in renewable output volatility when securing generation capacity sufficient to meet peak demand. However, declining minimum trading volumes leave more installed capacity idle, risking market inefficiencies. This output volatility also affects the profitability of renewable installations themselves. When renewable supply exceeds demand, exacerbated by limited transmission capacity, the power system cannot absorb the surplus and curtail renewable output. In such cases, renewable electricity produced at zero fuel cost is wasted with increasing frequency, eroding the profitability of renewable facilities.

To mitigate renewable output volatility and prevent large-scale blackouts, Korea’s wholesale electricity market must secure sufficient reserve capacity. Equally important is power system flexibility, such as energy storage systems (ESS) that store electricity when the renewable supply is abundant and discharge it when scarce to maintain balance. To attract investment and ensure sustained operation, the wholesale electricity market should establish incentive mechanisms that enable recovery of investment and operating costs.

Ⅲ. Basic Structure of the Wholesale Electricity Market

Power systems must match supply and demand in real time. Even slight imbalances can cause frequency deviations, leading to widespread blackouts or unnecessary increases in operating costs. Korea’s wholesale electricity market, where Korea Electric Power Corporation (KEPCO) and power producers trade electricity, is structured to ensure sufficient capacity to mitigate blackout risks, while avoiding overinvestment and minimizing total system costs to meet projected demand (Figure 3).

To this end, the wholesale market sets three prices for electricity supply (energy), standby power for immediate delivery on demand even when not generating (capacity), and frequency and voltage control to maintain real-time balance and grid stability (ancillary services).

The capacity price compensates power producers for maintaining standby resources, enabling system operators to secure long-term generation facilities and reliable reserve capacity. When renewable generation fluctuates sharply, pushing frequency outside acceptable limits, ancillary-service facilities provide flexible output control to restore frequency and prevent blackouts.

Spot market sets the prices for both energy and ancillary services on a day-ahead or real-time basis. Forward market sets capacity prices in advance to secure long-term, reliable generation capacity (Table 1). In Korea’s wholesale market, however, renewables do not receive compensation for capacity or ancillary services as they cannot reliably provide these functions. Instead, under the Renewable Portfolio Standard (RPS), renewable producers receive tradable certificates (Renewable Energy Certificates). The proceeds from selling these certificates are added to their energy settlement payments.

Ⅳ. Prices under Renewable Expansion in Competitive Wholesale Markets 

The wholesale electricity market encompasses several functionspecific markets that are closely interconnected. Their price signals shape investment and retirement decisions for generation facilities and influence the real-time operation of the power system. The growing renewable share can reshape the wholesale market and change the relative roles of its function-specific segments. Yoon (2024) analyzed these dynamics using a theoretical model of wholesale electricity markets that includes renewables, baseload generation, gas-fired generation, and ESS.

Analysis shows that the growing share of renewables raises capacity prices in markets where energy and capacity prices are flexibly determined (Figure 4). The price transmission unfolds through four channels.

① As renewables with near-zero variable costs gain market share, the system marginal price (SMP), or spot market energy price, declines on average, undermining the profitability of other energy sources and weakening their investment incentives for facilities in forward markets. To maintain the same reserve capacity, capacity prices must increase. ② Renewable growth also amplifies overall market volatility, creating greater uncertainty around supply and revenue streams for other energy sources. Such risk discourages new capacity investment, requiring higher capacity prices as compensation. ③ As weather-induced volatility in renewable output and electricity demand, moving in opposite directions, becomes more frequent, the reserve capacity required for supply stability increases. Meeting this need requires stronger investment incentives in forward markets, driving capacity prices upward.

With a constant share of renewables, capacity prices can vary with natural gas prices. Generators are dispatched each hour in merit order, ranked from lowest to highest marginal costs (per kWh), and the marginal cost of the last unit needed to meet demand sets the SMP for that hour. Because gas-fired generation has higher fuel costs than most other sources, ④ an increase in natural gas prices raises SMP. This dynamic provides investment incentives for new capacity even at lower capacity prices, thereby pushing down capacity prices.

Demand for ancillary services is expected to rise with the growing share of renewables. Solar and wind generation experience weather-driven volatility, posing a risk of grid frequency and voltage deviating from acceptable ranges. Without sufficient ancillary services to stabilize frequency and voltage within seconds or minutes, even small fluctuations can upset the real-time balance of supply and demand and heighten the risk of large-scale blackouts.
 

V. Structural Problems in Korea’s Rigid Pricing Rules

Rising renewable penetration has heightened volatility in the wholesale electricity market, underscoring the need for flexible generation capacity and adequate reserves to ensure system stability. This section examines Korea’s pricing mechanisms and their limitations to assess whether compensation structures in place provide sufficient incentives for investment in the required capacity.

1. SMP: Challenges of Applying Variable-Cost Pricing

In Korea’s wholesale electricity market, prices are not determined by producer bids but by the operator’s prior assessment of each generating unit’s fuel-based variable costs. However, this pricing mechanism is difficult to apply to renewables, which have virtually no variable costs. Renewables are priority-dispatched and do not participate in SMP formation. As a result, when temporary oversupply makes curtailment unavoidable, it is difficult to establish clear criteria for which generators should be curtailed first.

2. Capacity Prices: Rigidity in Assessing Fixed Investment Costs

Unlike overseas markets that adjust capacity prices in line with technological progress and changing market conditions, Korea determines capacity prices through a rigid methodology based on fixed investment costs, including construction costs. The Shin-Incheon Combined Cycle Power Plant, built in 1998 with a 30-year design life expiring soon, provides the reference cost, with only inflation and target reserve capacity used for adjustment. This approach remains blind to real changes in investment costs, arising from technological progress, tighter environmental regulations, or fluctuations in financing costs.

Rigid cost-assessment methods govern both SMP and capacity prices, preventing them from capturing market changes, such as renewable expansion and SMP swings, amid weak inter-market linkages. In major overseas electricity markets, capacity prices tend to fall when SMP rises due to higher natural gas costs (Figure 5). In the U.K., where solar and wind generation account for a substantial share, capacity prices have increased alongside renewable growth, consistent with theoretical expectations. In contrast, Korea’s rigid capacity pricing system struggles to adjust to changing SMP.

The rigid capacity pricing system risks undermining the ability to secure adequate reserves as renewables expand. If capacity prices fail to rise in step with increasing renewable shares, conventional sources such as thermal and nuclear plants lose investment incentives, as their utilization rates and profitability decline. Such rigidity in price-setting weakens the power system’s ability to respond to future electricity demand.

3. Ancillary Service Prices: Prices Moving Opposite to Demand

In Korea’s wholesale electricity market, demand for ancillary services has been increasing amid greater supply–demand variability and more frequent frequency deviations (Figure 6). Primary reserves, which provide immediate frequency control, expanded rapidly by 33.3% between 2021 and 2024.

Yet domestic ancillary service prices fail to reflect rising demand. A fixed total compensation amount—recently held at 48.5 billion won—is pre-allocated, and prices are set by dividing this amount by the previous year’s actual supply.18) This design creates a counterintuitive outcome: in years when ancillary service supply expands to meet higher demand, the price falls the following year (Figure 7). As a result, ancillary service prices undercompensate providers and weaken longterm incentives to invest in the flexibility resources the market needs.

Rigid pricing delays investment in flexibility resources critical to power system stability and weakens its ability to respond to renewable output volatility. ESS, such as batteries and pumpedstorage hydroelectric plants, exemplify this problem. ESS typically earns revenue by charging during low-price hours and discharging during high-price hours to capture price spreads, while also providing capacity and ancillary services. However, under Korea’s market design anchored in variable costs, hourly price spreads are narrow and compensation for ancillary services is similarly limited. This market structure undermines ESS revenues in the wholesale market and slows investment in these facilities.

VI. Policy Recommendations

As the renewable share grows rapidly, Korea’s wholesale electricity market risks operational strain without sufficient resources to mitigate volatility and provide flexibility. This study proposes policy recommendations to bolster market-based pricing principles across wholesale market functions and to limit potential distortions.

1. Improving Wholesale Pricing Mechanisms

As renewable shares rise sharply, the wholesale market must balance reliable supply with efficient price formation. Achieving this balance requires a market framework that secures sufficient revenue for critical resources such as ESS. This, in turn, demands stronger pricing mechanisms for energy, capacity, and ancillary services.

A key priority is transitioning from the current variable-cost approach to a competitive bidding system that allows power producers to submit price offers directly. Incorporating renewables and ESS into the system would enable SMP to better reflect supply-demand conditions and strengthen their role as a benchmark for market operations, including output curtailment.

Another priority is introducing market-based capacity prices to secure required reserves in advance. This measure would deliver stable revenue streams for investors, hold down consumer costs through competition, and encourage proactive capacity development.

Ancillary services also require transitioning toward mechanisms that send price signals aligned with demand. In the short term, allocations could be calibrated annually to account for renewable volatility and ancillary service needs, while in the long term, prices should be synced with demand. Such reforms would attract investment and spur technological advances in flexibility resources, reinforcing power system stability.

2. Bolstering Regulatory Independence and Expertise & Rationalizing Retail Prices

Improving the domestic wholesale electricity market structure and reinforcing market-based principles require parallel institutional reforms to limit market distortions. Above all, the independence and expertise of the market regulator must be strengthened. An independent regulator can ensure consistent oversight across the entire market, covering retail electricity pricing, wholesale pricing rules such as capacity and ancillary service compensation, and the monitoring of market power. As wholesale markets become more segmented and market-based principles are more firmly established, regulatory authorities will need stronger capabilities in market analysis and oversight, as well as greater legal expertise. Ireland and Italy operated rigid capacity pricing regimes akin to Korea’s until moving to market-based systems in 2017 and 2019. The transition exposed risks of market power abuse. Transparent and fair oversight is indispensable for ensuring SMP signals deliver investment and efficiency.

Lastly, structural bottlenecks in retail electricity prices must be addressed. As the renewable share shifts, SMPs for energy, capacity, and ancillary services fluctuate, changing settlement amounts between KEPCO and power producers. For example, while renewable expansion may reduce energy settlement payments, it can simultaneously drive up capacity and ancillary service payments, raising total settlements. If these changes are not passed through to retail prices, retailers and producers are left adjusting revenues within limited settlement resources. To ensure investment responds effectively to market demand, SMP fluctuations need to be reflected more directly in retail prices.