An Intro to Wholesale Energy Markets

We have recently released a number of videos exploring wholesale markets. In this blog we thought we would take a deeper look at some of the common and different features of wholesale energy markets around the world.

But first, why do you trade power and what is a wholesale energy market?

Power is a commodity much like gold, natural gas or lithium. These commodities are traded on markets where buyers and sellers come together to agree what their value is at different points in time.

Usually, you can trade commodities on spot markets, forward markets, and futures markets. The difference between these markets is as follows:

1. Spot markets and real-time markets – for example buying a gold bar today.

2. Forward markets are for a point in time in the future – for example buying gold for physical delivery in 2025.

3. Futures markets are financial only markets – for example if you buy gold futures for 2025, you won’t receive any gold in 2025 but will get paid the difference between your futures contract and the spot price of gold in 2025.

Unlike gold, natural gas and lithium you can’t easily store power, aside from putting it in a battery or a hydro lake. This means that power contracts can trade for very granular periods in time, as granular as 5-minute intervals in Australia. This is important because power has a very different value over the course of the day. 

Why do power prices change during the day?

Supply/demand principles determine the price of power for each point in time. The higher demand is, the more likely it is that more expensive generators need to run resulting in scarcity pricing. Typically power is more valuable over the morning and evening peak when energy demand is higher and is less valuable overnight and in the middle of the day when demand is lower. The opposite happens when supply is higher than demand, this lowers prices and can occur when renewable generation is very high or exceeds demand.

The granularity of pricing depends on the market structure - these typically include national, zonal and nodal prices. The GB energy market has a national energy price meaning that there is one power price for the entire country for every interval. Whereas the Australian NEM is a zonal market with a different pricing zone in each state, modified by Marginal Loss Factors reflecting the exact location of generators. Finally, the New Zealand power market is a nodal market with over 200 pricing nodes that change every 5 minutes.

Anything with a fuel cost or other opportunity cost will usually only run if the price they receive in the wholesale market is at or greater than their short run marginal cost (SRMC). Otherwise, they would be losing money. 

Renewable energy assets are different as their fuel cost is £0/MWh. This means that renewable generation assets will often offer to sell power into wholesale markets at or below £0/MWh. The reasons that renewables will generate at negative prices is that in many jurisdictions renewable energy assets receive subsidies or green certificates which can be very valuable or that the hassle of curtailing generation isn’t worth it i.e. it is unlikely households will curtail the solar on their rooftop if wholesale prices fall below zero and they may not have a price signal to incentivise them to do this.

Where do you trade energy?

The place where buyers and sellers of power meet to trade energy and in turn agree the value of power for a given time is called a wholesale market.

There can be a high barrier to entry to trade in the wholesale market. Typically, they are accessed by suppliers/retailers, generators, large energy users, banks, and aggregators. The barriers to entry include credit and collateral costs which exclude smaller players accessing these markets, alongside hiring a team of people and/or algorithms to monitor these markets on a 24/7 basis. 

Are wholesale energy markets the same across the world?

No. Energy markets are very different based on jurisdiction, they broadly fall into two categories. 

1. Spot/Energy only markets - these include the likes of Australian National Energy Market (NEM) and the New Zealand Energy Market. These markets are characterised by a single spot price determined by the centralised dispatch process which is run by the System Operator. Effectively, generators submit offers to the System Operator and are dispatched in a price (and system constraint) influenced merit order, with the marginal dispatch price setting the Spot price for each interval. Buyers and sellers of energy can still trade power ahead of this dispatch process; this is typically done via financially settled futures contracts and CfDs rather than liquid auctions.

2. Capacity markets - these include the likes of the GB Energy Market, Dutch, Spanish and French energy markets and the Western Australian Energy Market (WEM). These markets are characterised by a multitude of tradable markets that trade ahead of delivery. Generators then submit a physical notification (or their dispatch plan) to the System Operator alongside bids and offers to either turn down or turn up from that profile. In real time, the System Operator will accept bids/offers to ensure that supply equals demand, in the GB market this is via the Balancing Mechanism. As a result of this the bulk of value for many generators comes before this final balancing market, therefore understanding how the different tradeable wholesale markets relate to one another is vital.

There are pros and cons for both approaches, at the end of the day both mechanisms are using straightforward economic principles to determine the value of power at any given point in time. 

If you want to learn more about how Gridcog supports modelling wholesale energy revenue streams in different market structures, reach out here to speak to one of our team.

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