Electricity Markets

Market basics #

The spot market is where electricity is sold at a specific price, in half hour
intervals. So you buy the electricity, and the generator fires up and obtains
the energy, and then it gets transmitted to you. This creates a supply and
demand scenario, where electricity is constantly being bought and sold, so the
power stations are able to predict when to turn on and off, to maximize
efficiency. As a retailer, it is in your best interest to buy energy contracts
at a fixed cost, where the duration is as short as possible to fulfill your

An example in history where this came up is the energy crisis in
, where manipulation and corruption lead to the government
having to pay a fixed cost for a long duration, like paying $50 per MW for a
year contract instead of something like a half hour.

Along with the spot market, there is the futures market. The futures market
allows for an agreement to buy electricity at a certain price on a future
date. This is not a physical trade, but an agreement to buy electricity
through the spot market. All the products offered in an electricity market is
usually to follow economic theory, creating an economy where products are
offered to allow for competition as well as to lower risk. A future allows for
speculation on the spot price, so if you think the price will go up or down in
the future, you can buy a future and then you will be able to buy the spot
price for less.

The electricity market follows ideas that are found in the stock market,
except that the underlying reasoning differs. The derivative products such as
futures and options, mainly work to allow for smaller companies to be
competitive in the same market. The products work as hedges against risk,
letting traders participate in the market while preventing larger traders to
control the market.

Some factors to consider #

Being a commodity, electricity markets vary largely depending on the source of
energy. In hydro dominant areas, there arise the interesting problem of
needing to forecast the weather. Demand can be forecasted in deregulated
markets by looking at the consumption of households, but how do you figure out
the supply? Being able to predict the supply of energy means you can make
money off the electricity market, selling contracts at certain prices because
you know the general trend that the supply will be moving towards. For
example, if you could predict a drought, then you could sell contracts that
show the price of electricity moving upwards towards a certain price.

Another product I haven't mentioned is a FTR, which is a financial
transmission right. This product in the market is used to hedge (protect) risk
against transmission losses as electricity must physically move from 1 area to
another. This results in losses in the transmission, which will affect
electricity prices. The further you have to move the electricity from the
power station, the higher chance that something might fail along the way. This
allows for another product to be used, if you are able to predict how much
electricity can be generated.

What next? #

This is all just very basic stuff, a lot goes on into trying to be an energy
retailer. The basics is that you buy electricity from a generator, then with
the government and market mechanisms put into place, you can provide a
consumer with that electricity. By using smart meters, you are able to see the
consumption of a household, and be able to bill them accordingly. A trader
then wants to buy electricity for a lower price, in order to make a profit.

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