14.2 Electricity Market Structures and Clearing Mechanisms
5 min read•july 30, 2024
Electricity markets are complex systems that balance supply and demand for power. They come in various structures, from centralized pools to bilateral contracts, each with unique pros and cons. Understanding these structures is key to grasping how electricity is bought, sold, and priced.
Market clearing mechanisms determine electricity prices and dispatch schedules. These processes involve sophisticated algorithms that account for grid constraints, security requirements, and multiple time horizons. The design of these mechanisms significantly impacts , investment signals, and overall system reliability.
Electricity Market Structures
Pool-Based vs Bilateral Markets
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Pool-based markets centralize electricity trading through a common platform
Generators submit offers and consumers submit bids
Facilitates transparent price discovery
Examples include PJM Interconnection and ERCOT
Bilateral markets involve direct contracts between generators and consumers
Allow for customized agreements and long-term price stability
Often used for large industrial consumers or long-term power purchase agreements
Hybrid market structures combine elements of both pool-based and bilateral markets
Offer flexibility and risk management options
Example: UK's BETTA market, which includes both bilateral contracts and a balancing mechanism
Market Types and Time Horizons
Day-ahead markets
Participants submit bids and offers for each hour of the following day
Used for unit commitment and initial dispatch planning
Real-time markets
Operate close to actual delivery time (5-15 minute intervals)
Balance supply and demand deviations from day-ahead schedules
Ensure long-term resource adequacy
Generators receive payments for available capacity, separate from energy sales
Examples include PJM's Reliability Pricing Model and ISO-NE's Forward Capacity Market
Regulatory Framework and Impact
Regulatory policies shape market structures and rules
FERC Order 888 in the US mandated open access to transmission systems
EU's Third Energy Package aimed to create a single European electricity market
Market structure impacts:
Price formation mechanisms (marginal vs. average pricing)
System reliability through resource adequacy requirements
Overall market efficiency and competitiveness
Investment signals for new generation and transmission
Market Clearing Mechanisms
Price Determination Process
Market clearing algorithms match supply and demand
Determine market- and quantity
Based on submitted bids and offers from market participants
Aggregate supply and demand curves
Intersection point sets the market-clearing price
All accepted bids and offers receive or pay this price in markets
(LMP)
Accounts for transmission constraints and losses
Results in different prices at various nodes in the grid
Example: A congested transmission line between two areas can lead to higher LMPs in the import-constrained area
Pricing Rules and Settlement
Generators paid their actual bid prices
Can lead to more complex bidding strategies
Uniform pricing
All accepted offers receive the same market-clearing price
Encourages cost-reflective bidding
Settlement frequency impacts market dynamics
Hourly settlements common in day-ahead markets
5-minute settlements increasingly used in real-time markets for better alignment with system conditions
Security and Co-optimization
Security-constrained economic dispatch
Incorporates system reliability constraints into clearing process
Ensures feasible dispatch schedules that maintain grid stability
Co-optimization of energy and ancillary services
Simultaneously clears energy and ancillary service markets
Maximizes overall market efficiency
Example: CAISO's real-time market co-optimizes energy, spinning reserve, and regulation
Market Design Impact
Participation and Investment Incentives
Price caps and offer requirements influence generator participation
High price caps may encourage investment in peaking units
Alignment between dispatch instructions and prices
Minimizes need for out-of-market corrections or uplift payments
Scalability for large-scale systems
Ability to handle thousands of nodes and generators
Important for interconnected markets (European market coupling)
Key Terms to Review (18)
Capacity Markets: Capacity markets are mechanisms designed to ensure that electricity providers have enough capacity to meet future demand, especially during peak periods. These markets create an economic incentive for power generation companies to invest in additional generation resources or maintain existing ones. This setup is crucial for maintaining system reliability and balancing supply with fluctuating demand, as it helps ensure that sufficient generation capacity is available when needed, particularly in the context of evolving energy markets.
Clearing Price: The clearing price is the market price at which supply and demand for electricity are balanced in a competitive market. This price is determined through the process of matching offers from electricity suppliers with the bids from consumers or utilities. The clearing price plays a crucial role in ensuring that electricity is efficiently allocated among various market participants while also reflecting the true cost of generation and delivery.
Consumer surplus: Consumer surplus is the difference between what consumers are willing to pay for a good or service and what they actually pay. This concept illustrates the benefit consumers receive when they purchase a product for less than their maximum willingness to pay, reflecting the value of their satisfaction or utility gained from the purchase. In electricity markets, consumer surplus plays a vital role in assessing the efficiency of market structures and the effectiveness of clearing mechanisms.
Demand-side management: Demand-side management refers to the strategies and technologies used to influence consumers' energy consumption patterns, aiming to reduce peak demand and enhance energy efficiency. This approach connects the behavior of consumers with the broader energy grid, enabling better resource allocation and balancing supply and demand. By engaging consumers through incentives, education, and smart technologies, demand-side management seeks to create a more responsive and sustainable energy system.
FERC Regulations: FERC regulations refer to the rules and guidelines set by the Federal Energy Regulatory Commission, an independent agency responsible for overseeing the interstate transmission of electricity, natural gas, and oil. These regulations ensure fair competition, reliable service, and protection for consumers while also promoting innovation in the energy sector. FERC regulations play a crucial role in shaping how energy markets operate, including aspects related to grid management, market structure, and pricing mechanisms.
Grid Modernization: Grid modernization refers to the process of upgrading and transforming the electrical grid to enhance its efficiency, reliability, and resilience by integrating advanced technologies. This includes the adoption of smart grid technologies, renewable energy sources, and improved communication systems to facilitate better management of electricity generation, distribution, and consumption.
Independent System Operator: An Independent System Operator (ISO) is an entity that manages and oversees the electricity grid, ensuring reliable and efficient operation while facilitating competition in the electricity market. The ISO plays a critical role in balancing supply and demand, coordinating the flow of electricity across various transmission lines, and providing essential services such as market clearing and system reliability assessments.
Interruptible load: Interruptible load refers to a portion of electricity demand that can be temporarily reduced or turned off by the utility during peak periods or when the supply is constrained. This flexibility allows utilities to better manage grid reliability and efficiency, especially during times of high energy demand or system stress. By incentivizing customers to participate in interruptible load programs, utilities can mitigate potential outages and reduce the need for additional power generation.
Load Serving Entity: A Load Serving Entity (LSE) is an organization or utility that is responsible for supplying electricity to end-users, ensuring that they have the necessary power to meet their demand. LSEs play a critical role in the electricity market by procuring energy resources, managing the distribution of electricity, and maintaining reliability in their service areas. They often interact with various market structures and clearing mechanisms to ensure that supply meets demand efficiently.
Locational Marginal Pricing: Locational Marginal Pricing (LMP) is an economic method used in electricity markets to determine the price of electricity at specific locations based on supply and demand, including the cost of delivering power and the physical constraints of the grid. It connects pricing to actual market conditions by reflecting how much it costs to supply an additional unit of electricity at a specific location, considering both generation costs and transmission constraints. This approach is crucial for managing congestion and ensuring that electricity flows efficiently across the grid.
Market Design Principles: Market design principles refer to the fundamental rules and structures that govern how electricity markets operate, ensuring efficient, fair, and reliable outcomes for all participants. These principles guide the development of market structures and clearing mechanisms, facilitating competitive pricing, resource allocation, and system reliability within the electricity sector.
Market efficiency: Market efficiency refers to the extent to which market prices reflect all available information at any given time. In an efficient market, the prices of goods and services adjust rapidly to new information, ensuring that resources are allocated optimally. This concept is crucial in the context of electricity markets, where timely and accurate pricing is essential for balancing supply and demand.
Pay-as-bid pricing: Pay-as-bid pricing is a market mechanism used in electricity markets where each bidder submits a price at which they are willing to sell their electricity, and the market clears at these individual bids. This system ensures that sellers are paid based on the price they bid rather than a uniform market price, which can lead to different prices for different suppliers. It plays a crucial role in determining how resources are allocated and can significantly influence the behavior of participants in both energy and ancillary services markets.
Retail market: The retail market is the segment of the electricity market where consumers, or end-users, purchase electricity from suppliers for their own consumption. This market allows consumers to select their energy providers, leading to competition among suppliers and potentially lower prices and improved service quality. It serves as a crucial link between the wholesale electricity markets and the final users, impacting pricing mechanisms and energy choice.
Smart meters: Smart meters are advanced digital devices that record energy consumption in real-time and communicate this information back to the utility provider. They enable two-way communication between the consumer and the energy provider, allowing for better energy management and integration of renewable energy sources.
Supply curve: A supply curve is a graphical representation that shows the relationship between the price of a good or service and the quantity supplied by producers at those prices. In the context of electricity markets, the supply curve illustrates how much electricity suppliers are willing to produce and sell at different price levels, which helps in determining market clearing prices and overall supply dynamics.
Uniform Pricing: Uniform pricing is a pricing mechanism where all consumers pay the same price for electricity, regardless of the costs incurred by different suppliers or variations in demand. This approach simplifies the market structure and enhances transparency, allowing for a more predictable financial environment for both suppliers and consumers. It also relates to market efficiency by promoting fairness and equal access to energy resources.
Wholesale market: A wholesale market in the context of electricity refers to a platform where large quantities of electrical energy are bought and sold, typically between generators and retailers or large consumers. This market is crucial for balancing supply and demand on a larger scale, allowing for price discovery through competitive bidding processes. The functioning of the wholesale market impacts the overall electricity pricing and availability, serving as a backbone for electricity market structures and clearing mechanisms.