Wholesale Energy Market 101: What Is It, How It Works
Wholesale energy markets handle the bulk purchasing and selling of electric power, as well as gas and steam, by energy producers and consumers like utilities or energy retailers. Energy traders, financial intermediaries, like energy brokers, and large commercial and industrial consumers also participate in the wholesale energy market. Deregulation in the 1990s set the stage for the creation of wholesale energy markets and the restructuring of utilities around the world, including the US.
Understanding Wholesale Energy Market
Trading at the wholesale level involves the bulk purchasing and selling of goods at low prices. Retailers typically step in to buy goods at wholesale and sell these same goods at retail at a profit. Think of wholesale trading as selling products at wholesale to a retailer, not the end consumer.
Wholesale energy, in particular electricity, works similarly to wholesale trading. Large quantities of electricity are bought and sold in the wholesale electricity market by electricity producers (power plants) and electricity suppliers (retail energy providers or utilities). Independent power producers, and developers like Solis Renewables, can also participate in the buying and selling of electricity in the wholesale market.
Types of Wholesale Energy Markets
Unlike regulated electric service territories, independent system operators and regional transmission organizations (ISO / RTO) coordinate, control, and manage the flow of electricity and the buying and selling of electricity across the electricity system they manage. Think of the ISO / RTO as the accountant of the electricity system. There are seven ISOs and RTOs in the US that perform market operations like dispatching power plants to meet demand, balancing supply and demand in real-time, and acting as exchanges and clearinghouses for the trading of electricity.
Physical Markets and Financial Markets are the two types of wholesale energy markets. Physical markets involve the actual generation and transmission of electrons. Electricity prices in the physical markets are influenced by the supply and demand of electricity along with congestion and line losses. Financial markets are made up of financial institutions and traders who set electricity prices using futures contracts. These contracts can help stabilize electricity prices and aid utilities in their integrated resource planning.
Wholesale Energy Trading
Currently, electricity is produced and consumed instantly. The inability to store wholesale electricity in large quantities means that electricity demand and supply must be balanced in real-time, all the time. Deregulated electricity markets are managed by ISOs and RTOs who dispatch power plants to meet electricity demand and balance electricity on the system in real time. In addition, ISOs and RTOs act as clearing houses and exchanges for electricity trading activities.
Complex factors in the electricity market, like the inability to store electricity in large quantities, can lead to high electricity price volatility. To hedge this price volatility, electricity generators (power plants) and load-serving entities (distribution companies) lock in fixed-priced electricity contracts for electricity delivery in the future, usually one day in advance. This is called the Day Ahead Market (DAM). Combining the DAM and Real-Time market is what’s called a dual settlement market.
Risks of Wholesale Energy Purchasing
There’s an excellent book called The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron that I read as well as a documentary I watched called Enron: The Smartest Guys in the Room. Both the book and the film tell the story of the rise and fall of Enron, an energy, commodities, and financial services company based in Houston. Enron filed for bankruptcy primarily as a result of accounting fraud.
Market manipulation and inflated electricity pricing are notable risks of wholesale electricity purchasing. The California energy crisis in 2000-2001 was caused in part by Enron’s market manipulation that led to higher electricity prices for retail consumers. In short, Enron encouraged the removal of power plants from the California electricity grid for unnecessary maintenance. The removal of these power plants on the grid led to rolling blackouts leading to the interruption of electricity supply. As a result, electricity prices increased allowing Enron traders to sell electricity at inflated rates.
Benefits of Wholesale Energy Trading
Enhanced reliability, efficient dispatch of electricity generation resources, and more transparent electricity pricing are all cited as benefits of wholesale energy trading. Retail consumers like you and me generally care about reliability (how the grid normally operates) and electricity pricing as both impact our day-to-day life in a meaningful way.
Reliability refers to the concept of an electricity grid’s probability of conducting normal operations at any given time. The ability to deliver electricity to consumers when it’s needed when factoring in the frequency, duration, and scale of electricity supply disruptions is a key component of reliability. Dispatching generation resources is defined by how the system operator calls on power plants to meet electricity demand. Electricity pricing is straightforward - the price you pay for electricity.
Wholesale Energy Market Regulations
Electricity that you purchase was either generated or purchased by your utility which delivered that electricity to you. The Federal Energy Regulatory Commission (FERC) generally has jurisdiction over wholesale electricity sales including the sale of electricity between electricity producers and suppliers (utilities). In contrast, FERC doesn’t have jurisdiction over retail electricity sales - the sale of electricity between you and the electricity retailer or distribution utility. State regulators and public service commissions fill this role.
Retailer customers either purchase electricity from a utility in a regulated market or a utility or retail energy provider in a deregulated market. FERC regulates ISOs and RTOs in deregulated markets via electricity market proceedings for 1) proposed ISO / RTO market rule changes, 2) proposed changes to FERC regulations impacting one or more ISOs and RTOs, or 3) a complaint about unjust or unreasonable electricity rates.
Impact of Renewable Energy on Wholesale Energy Prices
Price suppression in wholesale energy markets is correlated with a decrease in the historical price of natural gas, the increased penetration of renewable energy resources like solar and wind, and the addition of more cost-effective natural gas power plants. Taken together, these market forces have contributed to the decrease in historical wholesale electricity prices as well as the retirement of thermal generation power plants.
Generally speaking, the decrease in natural gas prices is one of the primary factors leading to decreased wholesale market prices in recent years. However, the addition of solar and wind-generating resources, the retirement of non-economic thermal power plants, and a decrease in electricity demand also contributed. Taken in a vacuum, the absence of a fuel cost for renewable energy projects tends to decrease power prices over time.
Future of Wholesale Energy Markets in the US
Wholesale energy markets involve the bulk buying and selling of electricity between electricity producers (power plants) and electricity buyers (retail energy providers or utilities). Physical and financial electricity markets comprise the two types of transactions conducted in the wholesale electricity market. Wholesale energy trading allows the market to hedge volatility through a market mechanism called the Day Ahead Market. Market manipulation is a noted risk to deregulated markets while reliability, efficiency of generator dispatch, and transparent electricity prices as pros for wholesale electricity markets. FERC acts as the traffic cop in the wholesale market. As the penetration of renewable energy increases market share over time, it’ll fascinating to see this resource’s impact on pricing and grid reliability.
