Electricity Markets: A Comprehensive Guide
We can compare the electricity market to a bustling bazaar, where buyers and sellers come together to negotiate the price and quantity of goods. Like any other market, the electricity market operates on the basic principle of supply and demand. The electricity produced by power plants must match the amount consumed by consumers at any given time, or else imbalances in the grid can occur, leading to potential blackouts. This article will explore the fundamentals of the electricity market and how the key players are involved.
In simple terms, we trade commodities between buyers and sellers in an electricity market. These markets aim to ensure enough electricity to meet demand at all times.
In a power market, there are two main parties: producers (fossil fuels, nuclear, and sources such as wind turbines and solar panels that generate electricity) and consumers (e.g., retail companies that supply power to customers from large industrial consumers down to the household level).
Electricity is generated at power stations (sometimes distributed ones) and then sold by energy suppliers to consumers. The buying and selling of electricity are known as power trading and take the form of contracts to buy and sell electricity.
Producers and consumers are not the only players in this game. Before we jump into what kinds of markets we have in Europe, let us explain the role of all the market participants.
Who participates in electricity markets?
A complex network connects electricity market participants, enabling them to produce, transmit, and distribute electricity to consumers. How do these participants interact with each other?
Electricity producers produce large amounts of electricity using various technologies such as coal, gas, nuclear, and renewable energy sources. They sell their electricity via electricity contracts in the market, competing with other producers to provide power to the grid.
Power can be traded either on the exchange market or directly between two parties without the oversight of an intermediary exchange (see our article about OTC trading).
A so-called Balance Responsible party (BRP) is a legal entity that trades daily in power exchange on behalf of the customers and suppliers and also is responsible for balancing the difference between consumption and production so that in each trading interval (for example, in the Czech Republic currently 60 minutes) the difference is as close to zero as possible (because BRP usually does not have online data on all its actual consumption/production, its deviation is not equal to zero). In short, the BRP is responsible for its immediate balance between generation and consumption to the Market Operator.
The market operator conducts the accounting of deviations and sends it to all BRPs monthly.
The market operator (represented by OTE in the Czech Republic) also sets prices and facilitates transactions between the producers and consumers on the market platform. Market operator organizes day-ahead and intraday markets (we explain these terms below). Power producers offer their electricity, while buyers bid to purchase it to meet demand. The market operator then matches the bids to fulfill all requirements from market participants.
Although we may plan production and consumption as accurately as possible (to ensure supply meets the need), it can never be perfect, leading to deviations. The Transmission System Operator (TSO) responds to this 'imperfection' by intervening in cases where deviations need to be balanced to prevent blackouts and does so through Ancillary Services (AnS).
Besides managing the deviation, transmission system operators (TSOs) are responsible for managing the high-voltage power transmission lines that transport electricity from producers to distribution networks, while distribution system operators, DSOs, manage the low-voltage distribution networks that deliver power to homes and businesses.
What kind of markets do we have in Europe?
Although other regulatory models exist in different parts of the world, the EU has deregulated its electricity markets. Let's now look at the fundamental division of the European electricity markets.
To ensure the ongoing supply of electricity to clients at the lowest cost, buyers and sellers of energy finalize transactions ranging from years in the past to just a few minutes before "delivery" or when a light switch is turned on.
A "forward" contract is any electrical transaction made more than a day before delivery.
The main advantage of forward trading is to protect suppliers, buyers, and consumers from unforeseen price volatility. It enables buyers and sellers to come to an agreement and lock in a price well before the actual delivery of energy. Securing a contract in advance at a price that benefits both the buyer and the seller is a form of risk hedging and can reduce the cost of doing business for both sides.
Spot Market Trading
Any transactions after forward transactions, i.e., from the day before delivery to the last few minutes before delivery, are considered "spot" contracts. The spot market is separated into two major segments:
- The day-ahead market consists of an auction the day before delivery
- The intraday market allows market participants to trade constantly within the actual delivery date of the energy.
Day-ahead energy trading refers to buying and selling energy for delivery the following day. On day-ahead markets, we make sure that there is a sufficient amount of energy available to meet expected demand.
In a day-ahead market, buyers and sellers submit bids and offers for a specific quantity of energy at a particular price. The market operator then processes these bids and offers, and uses different algorithms to match buyers and sellers and determine the final prices for the day-ahead market. The prices that are determined in the day-ahead market are then used as a reference for the real-time market, which is used to buy and sell energy for immediate delivery.
The day-ahead market is never entirely in line with the actual intraday price because of constant fluctuations in the requirement for energy. However, it provides a good reference for future energy prices one day in advance.
Intraday trading on the European electricity spot markets refers to the buying and selling electricity on the spot market with a time horizon of the same day. This type of trading is done hourly/half-hourly/other (depending on the country), with electricity prices being set in real time based on supply and demand conditions.
Several factors, including supply and demand, determine intraday prices in energy trading. This is influenced by market conditions such as weather, fuel costs, and availability of renewable energy sources. In general, the intraday price reflects the current market conditions and is determined through a combination of market forces and the actions of buyers and sellers.
Other factors, such as the availability of transmission capacity and storage facilities, can also influence intraday prices. For example, if there is limited transmission capacity, the energy cost may be higher, as there is less ability to move the energy from where it is produced to where it is needed. Similarly, if storage facilities are being used to store excess energy, this can also affect the intraday price.
Intraday trading allows electricity users to adjust their electricity purchases in response to market conditions and take advantage of short-term price fluctuations. It is an essential part of the overall electricity market in Europe and helps ensure that the electricity system can operate efficiently and reliably.
The golden rule for all electricity market players should be to forecast their own consumption and production as accurately as possible in the pre-delivery (Day-ahead market) and at the time of delivery (Intraday market) and to equalize these positions. In an ideal world where no BRP has its own deviation, the total deviation is 0, the TSO does not need to use ancillary services, and total deviation payments are "zero", reducing the resulting electricity price for end-customers. Unfortunately, such a world does not exist, but we, Nano Energies, as a flexibility aggregator, can balance the system (or transmission system) - if it is out of balance - through flexibility, helping the grid to balance and our customers to make more profit from.