To recognize the quality betwixt wholesale energy markets and accepted financial markets, it's important to grasp the quality of trading electricity, compared to financial assets similar equities, bonds, and commodities. The astir important quality is that energy is produced and consumed instantly. At the wholesale level, energy cannot beryllium stored, truthful demand and supply indispensable perpetually beryllium balanced successful real-time. This balancing leads to a importantly antithetic marketplace plan compared to communal capital markets.
It has besides restricted entree to the wholesale markets due to the fact that portion the markets are open, their intimidating technicalities person kept less-experienced traders away. Regulators promote traders to articulation the markets, but imaginable participants indispensable amusement fiscal spot arsenic good arsenic method cognition to beryllium granted access.
It's not advisable to tackle these markets without capable know-how, and this nonfiction is lone a start.
Market Organization and Design
Energy markets are besides overmuch much fragmented than accepted superior markets. The day-ahead and real-time markets are managed and operated by Independent System Operators (ISO). These non-profit entities are organized on a physical grid statement commonly referred to arsenic web topology. There are presently 7 ISOs successful the United States. Some screen chiefly 1 state, similar the New York ISO (NYISO) portion others screen respective states, specified arsenic the Midcontinent ISO (MISO). ISOs enactment arsenic marketplace operators, performing tasks similar powerfulness works dispatch and real-time powerfulness equilibrium operations. They besides enactment arsenic exchanges and clearinghouses for trading activities connected antithetic energy markets.
ISOs don't screen the full U.S. powerfulness grid though; immoderate regions similar those in the southeastern states are bilateral markets wherever trades are done straight betwixt generators and load-serving entities. Some settlements are done done bilateral EEI agreements, which are the equivalent of ISDA agreements in powerfulness markets. Grid operations successful these states are inactive centralized to a definite extent. Grid reliability and balancing are operated by Regional Transmission Operators (RTO). ISOs are erstwhile RTOs that yet organized into a centralized market successful the sanction of economic efficiency done marketplace forces.
Volatility and Hedging
The deficiency of retention and different much analyzable factors pb to a precise precocious volatility of spot prices. To hedge immoderate of these inherent terms volatility generators and load-serving entities look to hole the terms of energy for transportation astatine a aboriginal date, usually 1 time out. This is called the Day-Ahead Market (DAM). This operation of Day-Ahead and Real-Time markets is referred to arsenic a dual colony marketplace design. The Day-Ahead prices stay volatile owed to the dynamic quality of the grid and its components.
Energy prices are influenced by a assortment of factors that impact the supply and demand equilibrium. On the request side, commonly referred to arsenic a load, the main factors are economical activity, weather, and wide ratio of consumption. On the proviso side, commonly referred to arsenic generation, substance prices and availability, operation costs and the fixed costs are the main drivers of the terms of energy. There's a fig of carnal factors betwixt proviso and request that impact the existent clearing price of electricity. Most of these factors are related to the transmission grid, the web of precocious voltage powerfulness lines and substations that guarantee the harmless and reliable transport of energy from its procreation to its consumption.
The Highway System Analogy
Imagine a road system. In this analogy, the operator would beryllium the generator, the road strategy would beryllium the grid, and whoever the operator is going to spot would beryllium the load. The terms would beryllium considered arsenic the clip it takes you to get to your destination.
Notice that I mentioned the road strategy and not simply roads, which is an important nuance. The road strategy is the equivalent of precocious voltage powerfulness lines portion section streets are analogous to the retail organisation system. The retail organisation strategy is made up of the poles you spot connected your thoroughfare portion the grid is made up of large energy pylons holding precocious voltage lines. ISOs and the wide marketplace are chiefly acrophobic with the grid portion retailers oregon Load Serving Entities (LSE) get the powerfulness from substations to your home.
So let’s retrieve this, cars are power, radical are the generators, the destination (a road exit and not idiosyncratic else’s home) is the load and terms is time. We’ll usage this analogy from clip to clip to explicate immoderate much analyzable concepts but retrieve that the analogy is imperfect, truthful dainty each notation to the analogy independently.
Locational Marginal Pricing
All ISOs usage a signifier of pricing called locational marginal pricing (LMP). This is 1 of the astir important concepts successful energy markets. The "Locational" refers to the clearing terms astatine a fixed constituent connected the grid (we’ll get to wherefore prices are antithetic astatine assorted locations successful a moment). The "Marginal" means that the terms is acceptable by the outgo of delivering 1 much portion of power, usually 1 megawatt.
Therefore, the LMP is the outgo of providing 1 much megawatt of powerfulness astatine a circumstantial determination connected the grid. The equation for an LMP mostly has three components: the vigor cost, the congestion cost, and losses. The vigor outgo is the compensation required for a generator to nutrient 1 megawatt astatine the plant. Losses are the magnitude of electrical vigor mislaid portion zipping on the lines.
These archetypal 2 components are elemental enough, but the past one, congestion is trickier. Congestion is caused by the carnal limitations of the grid, namely transmission enactment capacity. Power lines person a maximum level of powerfulness they tin transportation without overheating and failing. Losses are usually considered to beryllium vigor losses arsenic immoderate of the powerfulness heats the enactment alternatively of simply transiting done it.
Returning to our analogy, congestion could beryllium considered to beryllium postulation jams and losses would beryllium the equivalent of the deterioration and teardrop connected your car. Just similar you don’t interest astir deterioration and teardrop connected your car erstwhile visiting a friend, losses are reasonably unchangeable crossed the grid and are the smallest constituent of the LMP. They besides chiefly beryllium connected the prime of the roadworthy you are driving on.
Looking to Minimize Costs
So, fixed that LSEs are looking to minimize their costs, they trust connected the ISO to dispatch the lowest outgo generator to proviso them with electricity. When a low-cost generator is consenting but incapable to present powerfulness to a fixed constituent due to the fact that of congestion connected the line, the dispatcher volition alternatively dispatch a antithetic generator elsewhere connected the grid, adjacent if the outgo is higher. This is akin to having idiosyncratic other thrust to the destination adjacent though they unrecorded further away, but due to the fact that postulation is truthful bad, the idiosyncratic surviving person cannot adjacent get connected the highway!
This is the main crushed prices disagree by determination connected the grid. At night, erstwhile determination is simply a debased economical activity, and radical are sleeping, determination is plentifulness of country connected the lines and truthful precise small congestion.
So referring to our analogy, erstwhile determination are fewer radical connected the roadworthy astatine night, determination is nary traffic, and truthful the terms differences are chiefly caused by the losses oregon deterioration and teardrop connected your car. You whitethorn ask: “But not everybody volition instrumentality the aforesaid clip to thrust from their location to their destinations, and you said terms is the aforesaid arsenic driving time, however tin that be?”
Remember that prices are acceptable astatine the margin, truthful the terms is acceptable arsenic the adjacent portion to beryllium produced, oregon the clip it would instrumentality for the adjacent idiosyncratic to thrust to their destination. You would get paid that “time” careless of however agelong it took you to get to your destination. So is surviving adjacent to your destination the champion mode to get rich? Well, not exactly. Sticking to the analogy, gathering adjacent to the destination takes overmuch longer and is overmuch much costly.