Wiktor Wise
The electricity market is quite different from traditional financial markets, with electricity being produced and consumed instantly. This means that demand and supply must be constantly balanced in real-time, leading to a unique market design. In the US, electricity markets vary by region, with investor-owned electric utilities being either regulated or deregulated. Location is important in electricity markets because it determines the clearing price at a given point on the grid, with prices differing based on the cost of delivering one more unit of power, usually one megawatt. This is known as Locational Marginal Pricing (LMP) and allows wholesale prices to reflect the value of electric energy at different locations. LMP also accounts for congestion on transmission lines, which can cause prices to vary by location. Additionally, location-based emissions calculations are important for companies to understand, as they reflect the average grid mix in a specific location, while market-based emissions depend on an organization's specific energy procurement choices.
| Characteristics | Values |
|---|---|
| Electricity markets | Wholesale electricity markets, retail electricity markets |
| Wholesale electricity markets | Impact electricity supply across entire regions |
| Wholesale electricity market structures | Organized wholesale markets, regulated wholesale markets, restructured wholesale markets, deregulated wholesale markets |
| Wholesale electricity market regulation | Oversight of wholesale market operations by federal regulators, state public utility commissions |
| Wholesale electricity market participants | Independent power producers, non-utility generators, utilities, independent system operators (ISOs), regional transmission organizations (RTOs) |
| ISOs and RTOs | Operate in states with wholesale electricity markets, oversee regional transmission systems, foster competition, guard against market manipulation, facilitate grid planning and operations, ensure reliability, guarantee access to electricity grid |
| Retail electricity markets | Govern how individuals and organizations purchase power, offer retail choice to customers in specific states |
| Retail electricity market structures | Retail choice, regulated retail markets, vertically integrated markets |
| Retail choice | Customers can purchase electricity from suppliers other than their local utility, fosters competition, provides choices for resources used to generate electricity |
| Vertically integrated markets | Utilities are solely responsible for generating, transmitting, and distributing electricity, determine the mix of resources for generation |
| Location-based emissions | Reflect the average grid mix, include cleaner grid resources |
| Market-based emissions | Depend on specific energy procurement choices, can be higher with high-carbon intensity suppliers, lack of renewable energy contracts, more emissions-intensive residual mix factor than the local grid |
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What You'll Learn
Locational Marginal Pricing (LMP)
LMP aims to improve the efficiency of electricity systems by sending price signals to generators and customers, indicating when and where power is cheap or expensive. This helps in making informed decisions about infrastructure investments, enhancing grid stability, and promoting competitive markets for reliable power sources.
The LMP equation consists of three components: energy cost, congestion cost, and losses. The energy cost is the compensation required for a generator to produce one megawatt of electricity. Congestion cost refers to the marginal cost of congestion at a given node relative to the average system node prices. Losses represent the amount of electric energy lost during transmission along the power lines.
LMPs are also known as nodal prices, as they vary by location on the grid. This reflects the dynamic constraints of transmitting power across the grid, including congestion and losses. In an LMP system, a generator receives its local nodal price for its output, and a load pays this price or a zonal price derived from local nodal prices.
LMPs are calculated on an hourly basis and can fluctuate significantly between locations. Day-ahead LMPs are determined in advance, allowing participants to buy and sell wholesale electricity a day before operation, thus avoiding potential market volatility. Real-time LMPs, on the other hand, represent the price in real-time, enabling participants to buy and sell power during the day of operation.
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Wholesale electricity market structures
The wholesale electricity market is a critical component of the overall energy landscape. It refers to the buying and selling of power between generators and resellers. Wholesale electricity markets generally refer to power generators, transmission network operators, and financial markets that set the wholesale electricity price.
There are two main types of wholesale electricity markets: traditionally regulated markets and restructured or deregulated markets. In traditionally regulated markets, utilities are typically vertically integrated monopolies, meaning they are solely responsible for generating, transmitting, and distributing electricity to their customers. These markets are found primarily in the Southeast, Southwest, and Northwest regions of the United States. Utilities in these markets determine the mix of resources they use to generate electricity, with approval from state public utility commissions.
On the other hand, in restructured or deregulated markets, utilities that serve retail customers are only responsible for delivering electricity to those customers. The electricity is generated by other entities, which then sell the electricity they produce through competitive power markets known as "independent system operators" (ISOs) and "regional transmission organizations" (RTOs). ISOs and RTOs are independent organizations that oversee the generation and delivery of electricity to consumers in restructured markets. They manage the processes in which power suppliers compete based on price to generate electricity, and these processes inform wholesale electricity prices in those regions.
ISOs and RTOs operate in states with wholesale electricity markets and allow independent power producers and non-utility generators to trade power under the supervision of federal regulators. There are currently seven ISOs/RTOs operating in the contiguous United States: California ISO (CAISO), Electric Reliability Council of Texas (ERCOT), Midcontinent ISO (MISO), New York ISO (NYISO), New England ISO (NE-ISO), Southwest Power Pool (SPP), and PJM Interconnection (PJM).
One important concept in electricity markets is locational marginal pricing (LMP), which allows wholesale prices to reflect the value of electric energy at different locations by accounting for patterns of load, generation, and congestion cost. The "locational" refers to the clearing price at a given point on the grid, and the "marginal" means that the price is set by the cost of delivering one more unit of power, usually one megawatt. Thus, LMP is the cost of providing one more megawatt of power at a specific location on the grid.
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Retail electricity market structures
The location is important in electricity markets because it determines the electricity market structures that govern how individuals and organizations purchase power. In the United States, electricity market structures vary across states, with some states having restructured or deregulated markets, while others have traditionally vertically integrated markets.
Retail Choice
Retail choice, also known as "restructured markets," allows customers to purchase electricity from suppliers other than their local utility company. This structure fosters competition among electricity suppliers, leading to reduced prices and providing customers with choices regarding the resources used to generate their electricity. Retail choice is more common in states with restructured wholesale power markets but is also offered in some states with regulated wholesale markets, sometimes limited to specific customer types.
Vertically Integrated Markets
In vertically integrated markets, a single entity or utility owns and oversees the generation, transmission, and distribution of electricity to customers. This structure was prevalent in the early days of electrification as it was deemed a natural monopoly. However, some states have begun restructuring their energy markets to increase competition in electricity generation. In these restructured markets, utilities are required to sell their generation assets while retaining ownership of the transmission and distribution systems.
Wholesale Electricity Markets
Wholesale electricity markets impact electricity supply across entire regions and set prices for retail customers. Independent System Operators (ISOs) and Regional Transmission Organizations (RTOs) oversee wholesale markets and manage the competition between power suppliers based on price. ISOs and RTOs also operate portions of the electric transmission system and use bid-based markets to determine wholesale electricity prices.
Locational Marginal Pricing (LMP)
LMP is a pricing mechanism used by ISOs and the general market to reflect the value of electric energy at different locations on the grid. The LMP equation considers energy cost, congestion cost, and losses incurred while transmitting electricity over long distances.
State Commissions and Oversight
State commissions play a crucial role in retail electricity market structures by providing oversight and determining the rates that retail customers pay. They approve energy investments, oversee the rate of return on utility investments, and ensure that utilities serve all customers in their area. In restructured states, state commissions continue to provide oversight of the distribution utility that delivers power to customers.
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Location-based emissions accounting
Location is an important concept in electricity markets, especially in the context of emissions accounting. Electricity markets refer to the systems through which electricity is bought and sold, and they vary across different regions. In the United States, for example, electricity markets can be traditionally regulated or restructured (deregulated). In traditionally regulated markets, utilities are often vertically integrated monopolies, generating, transmitting, and distributing electricity with approval from state commissions that determine the rates customers pay. On the other hand, restructured markets allow independent power producers and non-utility generators to trade power under federal supervision, fostering competition and guarding against market manipulation.
The location of a company or consumer within these markets can significantly impact their access to green power products and the prices they pay. The concept of "locational marginal pricing" (LMP) is crucial in understanding the impact of location on electricity markets. LMP allows wholesale prices to reflect the value of electric energy at different locations by accounting for patterns of load, generation, and physical limitations of the grid. The "locational" aspect refers to the clearing price at a specific point on the grid, while "marginal" means the price is set by the cost of delivering one more unit of power. Thus, LMP is the cost of providing that additional unit of power at a particular location, taking into account energy costs, congestion costs, and losses during transmission.
Location also plays a significant role in emissions accounting for companies. Two distinct methods for calculating emissions from purchased electricity are the location-based approach and the market-based approach. The location-based approach considers the average grid mix in a company's location and does not factor in any renewable electricity or attributes purchased by the company. This means that a company's location-based emissions cannot be reduced through renewable energy instruments. On the other hand, the market-based approach depends on a company's specific energy procurement choices and can be higher or lower than the location-based emissions depending on those choices. For example, if a company's electricity supplier has a high carbon intensity, or if the company hasn't procured renewable energy through mechanisms like Power Purchase Agreements (PPAs) or Renewable Energy Certificates (RECs), their market-based emissions will be higher.
By understanding the relationship between location-based and market-based emissions, companies can make more informed decisions to achieve their decarbonization goals. For instance, to reduce market-based emissions, organizations can source electricity from suppliers with lower carbon intensity, secure renewable energy contracts, or purchase high-quality RECs. Additionally, ensuring proper accounting and avoiding double-counting of RECs can improve accuracy in emissions reporting. Furthermore, companies with aggressive carbon emissions reduction goals located in areas lacking renewable energy infrastructure can purchase environmental attributes from renewable energy developments elsewhere to meet their sustainability targets. However, it is crucial to disclose the physical emissions from fossil fuels to stakeholders in the interest of transparency.
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Market-based emissions accounting
The market-based approach to emissions accounting for purchased electricity represents emissions based on how an organization buys its energy. This approach considers contractual instruments such as Energy Attribute Certificates (EACs) like Renewable Energy Certificates (RECs) and Guarantees of Origin (REGOs) to track the origin of electricity and calculate GHG contributions.
The market-based method models the emissions from the electricity purchased (e.g. through direct contracts with suppliers or energy attribute certificates). It takes into account the emission intensity of different energy sources, so emissions will be lower if renewable energy has been purchased. It rewards low-carbon energy purchases and takes into account the carbon intensity of different sources of energy. It uses the electricity supplier's emissions factor rather than the general grid emissions factor.
Market-based reporting reflects emissions from the specific electricity a company purchases. It takes into account energy purchase agreements and energy contracts such as RECs, REGOs, or other energy contracts. It is most accurate when emissions calculations use energy supply-specific emission factors. For example, if a company buys its energy on the open market, it can ask the supplier to provide an emissions factor specific to the energy mix.
The market-based approach is also more flexible, allowing companies to claim the usage of clean electricity by purchasing EACs, enabling them to choose where they source energy from and where their organisational emissions are counted.
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Frequently asked questions
Electricity is produced and consumed instantly, whereas financial assets like equities, bonds, and commodities can be stored. Therefore, electricity demand and supply must be balanced in real-time. This leads to a significantly different market design compared to common capital markets.
Prices are different at various locations due to the clearing price at a given point on the grid. This is called Locational Marginal Pricing (LMP) and is the cost of providing one more megawatt of power at a specific location on the grid. The LMP equation includes energy cost, congestion cost, and losses.
Location-based emissions reflect the average grid mix in a particular area. Market-based emissions depend on the specific energy procurement choices of an organization. If an organization's electricity supplier has a high carbon intensity, its market-based emissions will be higher than location-based emissions.
