Types of Markets
The North American electric grid is sometimes referred to as the “world’s largest machine”—an interconnected system serving nearly 400 million consumers. It’s a machine that must operate within clearly defined parameters, delivering a product that must be consumed the instant it’s generated. The entire system is predicated upon maintaining perfect balance: supply and demand must always be equal.
So how exactly do electricity and grid services markets meet the demands of this complex machine? This section will explore the various “markets within the marketplace” that enable grid operators to maintain reliable electric service at the lowest possible cost.
These are the primary markets used to meet daily power demand in ISO/RTOs, determining which resources will be dispatched to supply electricity and which resources are surplus to requirements at any given moment.
While markets are intended to operate on a technology-neutral basis, the reality is that markets are still adapting to the changing resource mix. They have their own policies and structures that require refinement as new technologies change the dynamics and states seek to realize policy goals. In recent years, FERC has stepped in to remove barriers to market access for various new resources, including demand response, energy storage and distributed energy resources.
On the one side, there are load-serving entities—primarily distribution utilities—which submit bids to purchase a certain amount of electricity to serve their customers’ electricity demands. On the other side, power resources—including power plants that supply electricity and demand-side resources that reduce load—submit offers to satisfy that electric load at a certain price. In the middle, the ISO/RTO “clears” the market when the amount of power resources meets the demand for electricity. Every resource that clears the market is then compensated at the highest clearing price, and the power they bid into the market is dispatched into the system and consumed. The resources that didn’t clear—the ones that bid above the clearing price—remain unused and unpaid through that period.
In this way, ISO/RTOs dispatch based on the lowest cost mix of resources needed to reliably meet demand. The greater the demand, the higher the cost of electricity as more expensive resources are dispatched to satisfy demand. When the system is truly strained and nearing its limits, with even reserve capacity running low, ISO/RTOs may implement “scarcity” or “shortage” pricing to substantially increase energy and ancillary service market prices. In doing so, the ISO/RTO signals the need for all quick-start and fast-ramping resources in order to stabilize the system. These price signals—which can reach as high as $2,700/MWh in PJM or $9,000/MWh in ERCOT—are often sufficient to incent the development of “peaker” resources, designed to run only during scarcity events.
ISO/RTOs operate two distinct energy markets: one to satisfy the bulk of demand based on load projections for the next day, and the other operated in near real-time to make up for the differences between projections and reality.
Day-Ahead Energy Markets
Day-ahead markets are exactly what they sound like: they’re markets based on the forecast load for the following day. These forecasts are based on incredibly detailed modeling algorithms that use artificial intelligence and incorporate inputs like weather forecasts and historical usage data to anticipate hourly system demands over the next 24 hours. This information is used to run a day-ahead market for every hour of the coming day, allowing the ISO/RTO to line up ahead of time—or “commit”—the resources necessary to satisfy that anticipated demand.
These forecasts are extremely accurate. A recent analysis based on data from the U.S. Energy Information Administration revealed that ISO/RTO day-ahead hourly projections on average missed real demand by less than 3%, with CAISO and ERCOT off by an average of 2.3% over a six-month timeframe.
Real-Time Energy Markets
As accurate as these load forecasts are, they’re still forecasts and demand for electricity fluctuates in real-time based on factors that aren’t entirely predictable. For that, ISO/RTOs rely on real-time markets to make up the balance between the day-ahead market’s projections and real-world demand.
Real-time markets operate at five-minute intervals in most ISO/RTOs. Using the same methodologies, markets dispatch additional resources throughout the day to balance the grid and make up for however much the forecasts were off.
By design, energy markets are competitive. That’s normally a good thing. More expensive resources become increasingly uneconomic if they can’t reduce costs or survive through scarcity pricing alone. Less expensive resources thrive, leading to lower power costs for load-serving entities and, ideally, lower power bills for consumers.
However, as the nation has witnessed during recent events, it can be dangerous to focus primarily on lowering system costs without an adequate eye for reliability or resilience. As an essential service that is vital to health, safety and economic activity, government oversight of the power sector has always been designed to ensure reliable service at just and reasonable rates. Unfortunately, reliability and low rates are not complimentary. In fact, they’re often at odds with one another. And without the right structures, market operators may unintentionally emphasize low-cost power over system reliability.
This is the idea behind capacity markets, which aim to secure forecast capacity and adequate generating reserves several years down the line. In essence, this is a market to help ISO/RTOs plan for bulk power system requirements, ensuring that longer-term demand projections are reliably met with adequate generating capacity. Depending on the ISO/RTO, the capacity market may be several months or several years ahead. Capacity markets are also intended to incent new resource development by signaling additional system capacity requirements and providing more certainty for those investments through a pathway to recover fixed costs over time.
Capacity markets—or a lack thereof—are where ISO/RTO differences are most starkly apparent. PJM and ISO-NE run capacity auctions to secure capacity three years down the line. Both markets are regional and primarily composed of states that restructured their electricity markets. Meanwhile, MISO and SPP are primarily composed of states with traditional utility regulatory systems. Utilities in these states own generation and primarily use the state-regulated integrated resource planning process to satisfy resource adequacy requirements. MISO operates a voluntary capacity market for utilities to secure the balance of projected demand. SPP does not offer a capacity market; it requires market participants to maintain enough capacity to cover their obligations.
CAISO and ERCOT also don’t operate capacity markets. CAISO has established mandatory resource adequacy rules, which require distribution utilities to procure 115% of their aggregate system load every month and obligates those resources to be available. ERCOT, on the other hand, relies on energy market signals to fully compensate existing resources and incent development of new resources. This method relies on the use of scarcity pricing as an incentive to develop resources that will meet peak demand.
Ancillary Services Markets
Ancillary services refer to a number of services that are used to maintain reliability in the short-run and support the electric transmission system. These services are supplied and consumed in real-time and include the following:
Regulation: If the real-time market makes up for the shortcomings of the day-ahead market, regulation services make up for the shortcomings of the real-time market. This service is provided to resources that can respond to the imbalances between load and supply that occur between the five-minute real-time energy market signals in order to maintain a more exacting system balance.
Reactive Power: This provides compensation for resources that help the grid operator maintain system current and voltage, either by providing incremental voltage or absorbing voltage necessary to move electricity on the transmission system.
Operating Reserves: The purpose of this market is to make up for sudden losses that could cause sudden system imbalances. These are provided to highly responsive generating units or demand-side resources that can either increase output or reduce demand quickly. There are three primary types of reserves:
- Spinning reserves are already operating and synchronized with the grid, often with some capacity to spare that can be quickly converted to energy, as needed.
- Non-spinning reserves are from resources that are not in operation but can start up quickly (often within 10 minutes) to provide the needed energy within a short amount of time.
- Supplemental reserves are resources that may take longer to start up (perhaps requiring up to 30 minutes) and would only be required if spinning and non-spinning reserves were insufficient to respond to the grid’s needs.
- Black Start: These units can restart the power grid in response to catastrophic failures. They can start themselves and deliver electricity without external assistance. Hydroelectric facilities and diesel generators are some of the primary suppliers of this service.
Energy Imbalance Markets
Imagine a real-time market operator with no authority over transmission. This, essentially, is an energy imbalance market and it’s the type of market that’s been deployed throughout much of the West. Within these markets, individual utilities do not relinquish autonomy. They still operate their own resources and transmission system, are still responsible for planning for both of those systems.
In practice, these are voluntary platforms through which utilities can buy and sell electricity among the participants, based on their system’s needs. For participating utilities, this establishes a more efficient platform for buying or selling excess generation. Depending on how the market is set up, it may also allow IPPs to sell electricity, which some advocates have argued will lead to increased development of lower-cost resources by independent entities.
Clearing the Market Example
- Load-serving entities notify an ISO/RTO that there is 100 megawatts (MW) of unserved load over the coming hour. The ISO/RTO receives 15 bids from power resources, each for 10-megawatt hours (MWh).
- Five resources at $20/MWh. Five resources offer at $30/MWh. Five resources offer at $40/MWh.
- The market would clear at $30/MWh. Each of the 10 resources to clear the market would receive $30/MWh. In this way, the ISO/RTO satisfies the 100 MW of demand.