The practice of trading power between participants in the electricity sector is referred to as power trading. Depending on the market design, various types of power trading are accessible, from short-term spot markets to long-term over-the-counter markets. Before it is delivered to end customers, these markets allow the trading of electricity between power producers, major industrial consumers, and electricity retailers. As a result, they are sometimes known as wholesale electricity markets.

Who is involved in electricity trading?

In a power market, there are two main parties: generators (fossil fuels, nuclear as well as sources such as wind turbines and solar panels that generate electricity) and consumers (from large industrial consumers of energy down to the household level).

Electricity is created 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.

How are electricity contracts made?

Power trading takes place on both short and long-term timeframes, the delivery of the energy can be over years to the same day. Generation and supply must satisfy the exact customer demand for each moment of the day. This makes it necessary that those operating on markets are prepared to buy or sell power to fill any unexpected gaps in their portfolios.

Factors such as exchange rates, cost, the availability of fuel, and changing regulations and policies all influence the price when trading electricity far in advance. The short-term price is more fundamental; factors like weather, news events, holidays, and even what's on television have a big impact on price.

An example of this last one can be major sporting events like the world cup; there can be a measurable impact on power markets as everyone turns off their television at the end of a match. 

Traders study live generation data and news reports to forecast how much power will be required during periods of high demand, and then set a price. Traders then make bids and offers to suppliers, agreeing on terms - these agreements then determine how and when a power station's generators are operated every day.

Where are electricity contracts made?

Electricity contracts can be made on an exchange or over the counter (OTC). An exchange is a marketplace where buyers and sellers come together to trade standardized contracts, such as futures and options.

Exchange Trading

Exchange trading in energy markets refers to the buying and selling of energy contracts on an organized exchange platform. In an exchange-traded market, buyers and sellers are able to trade standardized contracts for energy commodities such as oil, natural gas, and electricity. The exchange acts as a central marketplace, providing a transparent and regulated environment for trading.

In addition, exchange trading offers increased liquidity, as it brings together a large number of buyers and sellers in a single marketplace. This makes it easier for market participants to find counter-parties for their trades and enables them to execute transactions more quickly and efficiently.

Over-the-counter (OTC) Trading

OTC markets are private agreements between two parties that are not traded on an exchange. These contracts are typically more customized and flexible than those traded on an exchange. In both cases, electricity contracts are used to buy and sell electricity at a pre-agreed price and time in the future.

The most basic over-the-counter market is one in which participants trade directly between two people, or make use of a broker, without the need for a centralized exchange. Although it is possible to use OTC trading for spot market deals, there are a few reasons why this is usually not done. However, for trading forwards or futures, OTC is often the only market available for trading these types of deals.

The benefits of OTC trading are usually lower fees and transaction costs, however, the barriers to participating in these markets are usually higher than in exchange-traded. With that said, OCT trading is common around the world and represents the highest volume of trading in many markets.

Forward and Spot market

Electricity is unique because it cannot be stored reliably at scale. This, as well as other more technical variables, can cause spot prices to be extremely sensitive. Therefore prices can fluctuate quite significantly when issues occur in the supply of energy. To address some of the inherent price volatility, markets have been established which set the cost of electricity for delivery at a later date, usually, one day ahead. This is also known as the day-ahead market. 

Forward Trading

Buyers and sellers of energy finalize transactions from years in the past to only a few minutes before a light switch is turned on ("delivery") in order to guarantee the ongoing supply of electricity to clients at the lowest cost.

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 in advance of 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.

Forward Trading can promote decarbonisation

The majority of renewable energy generators have large upfront investment costs. These projects might be challenging to raise funding for since lenders expect significant upfront expenses and revenue that won't come in for several years.

One type of forward contract in energy is the power purchase agreement (PPA) This makes it simpler to obtain money to finance renewable energy projects. This is because they offer a type of collateral of “the value of future energy production” that can demonstrate to lenders that a project is viable. Being able to operate renewable sources on the ancillary services markets can further support the business case of such installations and dramatically improve the payback period.

Spot Market Trading

Any transactions which take place 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 Trading

Day-ahead energy trading refers to the practice of buying and selling energy for delivery on the following day. This takes place in day-ahead markets, which ensure 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. These bids and offers are then processed by the market operator, who 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 completely 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

Intraday trading on the European electricity spot markets refers to the buying and selling of electricity on the spot market with a time horizon of the same day. This type of trading is done on an hourly basis, with electricity prices being set in real time based on supply and demand conditions. 

Intraday prices in energy trading are determined by a number of factors, including supply and demand. This is influenced by market conditions such as weather, fuel costs, and availability of renewable sources of energy. 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.

Intraday prices can also be influenced by other factors, such as the availability of transmission capacity and the use of storage facilities. For example, if there is limited transmission capacity, the price of energy 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 changes in market conditions and to take advantage of short-term price fluctuations. It is an important part of the overall electricity market in Europe and helps ensure that the electricity system is able to operate efficiently and reliably.

How do spot markets promote decarbonization?

The spot market allows operators of low-cost energy production units, primarily renewables, to be chosen first to produce the electricity required by consumers. This is known as merit order.  This guarantees that they are utilized to the greatest extent possible.

Renewable power-generating units can also recoup a portion of their investment costs thanks to marginal pricing in the day-ahead auction, reducing the need for financial assistance from public budgets.

As renewable energy generation continues to grow, more solutions for when the wind does not blow or the sun does not shine will be required. Spot markets, particularly intraday markets, enable swiftly reactive technology such as peak electricity generation or battery storage, as well as reactive consumers to offer their flexibility over short periods of time when needed. In Europe, this process is managed via ancillary services markets.

Renewable power-generating units can also recoup a portion of their investment costs thanks to marginal pricing in the day-ahead auction, reducing the need for financial assistance from public budgets.

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Spot markets support low-cost, low-carbon power-generating sources, which aids in the EU's efforts to reduce its carbon footprint. They also assist in valuing the technologies and services required for the energy transition, such as demand response and electricity storage.

Cross-border trading

In Europe, cross-border energy trading refers to the exchange of electricity and natural gas between countries. This is made possible through the development of a single market for energy, which allows for the free flow of energy across national borders. This is facilitated by a number of interconnected transmission networks, that enable the transfer of energy from one country to another.

Cross-border trading within the EU is developing in a way to strengthen energy security and balance prices. Different countries have different energy mixes that can complement each other and improve resilience. Cross-border energy trading in Europe helps to increase competition and reduce energy prices for consumers, while also ensuring that there is a reliable and secure supply of energy across the region.

Short-term Trading

Short-term trading refers to the buying and selling of electricity on the European electricity network with a time horizon of one year or less. This can include the trading of electricity spot prices, as well as the buying and selling of futures and options contracts with shorter maturities. The goal of short-term trading is to provide electricity users with flexibility in their electricity purchases and to help balance supply and demand on the grid. It is an important part of the overall electricity market in Europe and helps ensure that the electricity system is able to operate efficiently and reliably.

Nano Energies can help you lower your costs as well as sell your energy more effectively and provide new sources of revenue. Contact us to understand how you can make the most money from your power assets.

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