Wholesale electricity

Electricity - the wholesale electricity market:

A wholesale electricity market exists when competing producers to sell their electricity output to retailers. Electricity is difficult to store and will be available on demand. Therefore, unlike other products, it is not possible that under normal operating conditions, keep it in stock, ration it or have customers queue for it. Demand and supply vary continuously. There is therefore a natural need for a controlling body in the power system operator to coordinate the deployment of units to meet the expected demand of the system across the transmission network. If there is a mismatch between demand and supply of generators to speed up or slow down causing the system frequency (either 50 or 60 Hertz) to rise or fall. If the frequency falls outside a predetermined range of the system operator will act to remove either generation or load.

Moreover, the laws of physics determine how electricity flows through a power grid. Therefore, the amount of electricity lost in transmission and the degree of congestion on a particular branch of the network affects the economic dispatch of plants.

For an economically efficient electricity wholesale market to flourish, it is important that certain criteria are met. Professor William Hogan of Harvard University has identified them. Central to his criteria is a coordinated spot market, there is bid-based, security-constrained, economic dispatch with nodal prices ". Other scholars as Professors Pablo Player and Shmuel Orem from the University of California, Berkeley have developed other criteria. Professor Hogan's model is been widely adopted in New Zealand and supported by the U.S. Federal Energy Regulatory Commission in its draft of a Standard Market Design.

Electricity market - Bid-based security-constrained economic dispatch with nodal prices:

The theoretical price of electricity in each node in the network is an aggregation of the marginal electricity generator's offer price and the marginal cost of losses and congestion on the network. This is known as locational marginal pricing (LMP) or nodal pricing and used in some deregulated markets, especially in the PJM market in the U.S. and in New Zealand. But many established markets not employ nodal pricing, examples are the UK and Nord Pool (Scandinavia). In LMP markets where there are bottlenecks in transmission networks, there is a need for a load to be shed or the more expensive generation to be dispatched on the downstream side of coercion. Prices of both sides of the constraint separate giving rise to congestion pricing and forced rentals.

A limitation may arise when a particular branch of a network reaches its thermal limit or when a potential overload will occur due to a contingent event on another part of the network. The latter is referred to as a security force. In essence, the transmission systems are operated to allow for continuity of supply, although a contingent event, as the loss of a line generator or a transformer that arise. This is known as a limited safety system.

The marginal generator is determined by matching offers from generators to bids from retailers in each node to develop a classic supply and demand equilibrium. This process is implemented for every 5 minutes, half hour or hour (depending on market) range for each input and output node on the transmission grid. The prices take account of losses and constraints on the system and generators that are dispatched by the system operator, not only in increasing order of bids (or descending order of bids), but in accordance with the required security system. This results in a spot market with bid-based, security-constrained, economic dispatch with nodal prices ".

The electricity market - Risk management:

Financial risk management is often a high priority for participants in deregulated electricity market because of the high price and quantity risks that markets can exhibit. One consequence of the complexity of a wholesale electricity market can be extremely high price volatility during times of high demand and supply problems. The characteristics of this price risk is highly dependent on the physical underpinnings of the market, such as the mix of types of generation plant and the relationship between demand and weather conditions. Price risk can be manifest by price "spikes" which are difficult to predict and price "steps" when the underlying fuel or plant position changes for long periods. "Volume risk" is often used to describe the phenomenon of electricity market participants uncertain quantities or volume of consumption or production. For example, a retailer is able to accurately predict consumer demand for a particular hour more than a few days into the future and a producer is unable to predict the exact time that they want to plant outages and fuel shortages . A blend factor is also the common link between extreme price and volume events. For example, price increases, which often occurs when some producers have plant outages, or when some consumers are in a period of peak consumption.

Electricity retailers in the total purchases on the wholesale market, and generators, which together sell on the wholesale market, which is exposed to these price and quantity effects and to protect itself against fluctuations, they will conclude "hedge contracts" with each other. The structure of these contracts depends on the regional market because of various conventions and market structures. But the two simplest and most common forms are simple fixed price forward contracts for physical delivery and contracts for differences where the parties agree a strike price for certain periods. In case of a contract for difference, if the result of the wholesale price index (as referenced in the contract) in a period is higher than the "strike" price, the generator will refund the difference between the "strike" price and actual price for that period. Similarly, a retailer will refund the difference to the generator when the actual price is lower than the "strike price". The real price index is sometimes called the "spot" or "pool" price, depending on the market.

Many other hedging arrangements, such as swing contracts, the Financial Transmission Rights, call options and put options traded in sophisticated electricity markets. Generally, they designed to transfer financial risks between the participants.