Electricity behaves like no other commodity, which makes electricity markets complicated. An in-depth understanding of electricity markets requires integrating power system engineering, economics, regulatory policy, and business strategy. This blog identifies the key concepts and how they interact to jump start learning about and analyzing these markets.
Whether one is in the electric power industry or has an interest in energy and environmental issues, understanding electricity markets is critical. Electricity undergirds the economy and is the starting point for transitioning to a clean energy future. The future of this industry is up in the air as its fundamental premises are coming into questions (http://energy.mit.edu/research/utility-future-study/). Emerging technologies are challenging the grid’s technological organization and expanding public policy objectives are stretching the demands put on the industry.
One key characteristic of electricity’s unique status amongst commodities is that supply and demand must be balanced almost instantaneously. To keep this balance, the grid is planned and operated so that that there are sufficient reserves and operating flexibility, since electricity is extremely expensive to store in large volumes. If supply and demand are not in balance, then reliability is threatened and large-scale blackouts may occur. The industry refers to blackouts as cascading failures, because when supply does not meet demand power plants and transmission lines start tripping off-line one after the other. Besides the reliability implications, the market repercussion is that wholesale electricity prices can be extremely volatile.
A second important characteristic of electricity is loop or parallel flows. The grid is a network of generation units and transmission lines. For reliability reasons, there are multiple paths to move electricity from generation to the distribution systems. When power enters the grid, it spreads over the available transmission paths based upon the laws of physics. Electricity is not directed from the seller of power to the buyer. Instead, it is injected into the grid and flows from sources to sinks. The inability to direct the flow of electricity requires an indirect approach by adjusting the dispatch of generation units to avoid violating transmission limits. Because of loop flow, transmission congestion can occur, which has important implications for pricing wholesale electricity.
A third characteristic is that many generation units require hours, if not longer in some cases, to start up. Power plants that boil water to make steam to produce electricity take time for that water to be heated sufficiently. Thus, the grid operator must make decisions each day whether to commit units to be ready for the next day. This unit commitment issue requires an inter-day planning and market mechanism.
A fourth characteristic is that ancillary services are needed to generate and transmit electricity reliably. These services must be procured and paid for either as part of the electricity market or through a regulatory mechanism that does not interfere with the market.