by Tanya Bodell, CRA International
Competitive wholesale electricity markets in the U.S. have evolved substantially. There are now many ways an electron, or the promise of an electron, can generate value. As we move toward a new energy economy, expect to see new markets that define new values.
Energy-only markets conceptually pay a single price for power. This price is supposed to cover the variable costs of production (e.g., fuel and variable operations and maintenance) and the fixed costs (e.g., capital investment and the return on that investment required to encourage new entrants). Market price caps, however, limit the magnitude of price spikes, resulting in missing money otherwise required to cover fixed costs of production.
Capacity markets developed to cover the missing money that power suppliers could not earn in energy-only markets. New England, New York, PJM Interconnection and Midwest Independent Transmission System Operator Inc. (MISO) have implemented capacity markets in some form, and prices have been set by competitive auctions for future megawatts of capacity. Demand-side response has been a big winner in some of these markets, foreshadowing the potential for price-responsive retail consumption to participate in wholesale markets.
Several wholesale electricity markets include day-ahead and real-time settlement. Day-ahead markets allow the market operator to schedule generation resources and set prices for market participants in advance of actual real-time prices. The divergence of settlement prices between day-ahead markets and real-time spot markets created implicit arbitrage opportunities. Virtual markets arose to allow for explicit hedging opportunities. Competition has since whittled down the differential to reflect a day-ahead risk premium.
Financial Transmission Rights
Locational marginal pricing considers transmission constraints in setting the market clearing price. For those markets with nodal pricing, markets for financial transmission rights hedge the basis differential between generation node and delivery point.
Renewable energy credits (RECs) formalized a separately defined property right associated with renewable resources. Generation information certificates allowed for further differentiation. Markets for these environmental commodities establish verifiable claims for green power retailers and compliance with renewable portfolio standards. RECs are being further defined into solar renewable energy credits (SRECs) to generate separate revenue streams for future solar installations, and there has been discussion about alternative energy portfolio standards that include energy efficiency in the separately traded form of negawatts.
And More to Come …
With advanced metering, smart grid penetration and energy storage solutions, the following markets already are in discussion:
Frequency Markets: Higher wind penetration creates operational implications for the transmission system. Whereas traditional market ancillary services focus on system variability in minutes, hours and days, generators contribute to power system frequency regulation by controlling primary energy supply rates in seconds to minutes. Not always able to self-supply frequency control, increased wind penetration may require new markets for frequency support services.
Demand-side Bidding: Demand-side bidding has been incorporated into energy markets on a limited basis—most recently through capacity markets. As automated demand control equipment and hybrid electric vehicles offer energy storage and demand response at the retail level, wholesale electricity market rules may be revisited. Demand-side bidding would allow demand resources, in combination with generators, to set real-time prices, thereby creating a market that accounts for and possibly changes the price elasticity of demand.
Economists design markets to send proper and transparent price signals to decrease the transaction costs of matching supply to demand. As competitive wholesale electricity markets evolved, market forces have been at work. Property rights and new markets for transacting those rights have developed. A world with energy efficiency, electricity storage and renewable resources will need new markets to further define the sources and value of otherwise indistinguishable electrons.
How should you respond? Be prepared to participate. Reactive market participants respond to opportunities that new and transitioning markets generate. Proactive firms increase profits by directing the formation of these new markets and then participating in those markets with vantage.
Tanya Bodell is vice president of CRA International Inc. E-mail her at Tanya.firstname.lastname@example.org
“The most important single central fact about a free market is that no exchange takes place unless both parties benefit.”
– Milton Friedman