The electricity market - and its effect on electricity prices
Understand how the wholesale electricity market works, its effect on energy prices, and the revenue opportunities it offers to businesses.
Maintaining a secure supply of electricity to homes and businesses across the UK is essential. However, electricity can’t yet be stored cost-effectively in sufficient quantities to keep the system going. So, to make sure that the power we need is always available, the market must match the demand for and supply of electricity on a second-by-second basis.
The generators, suppliers, traders and customers who compete in the wholesale electricity market perform this process and the Balancing Mechanism of National Grid keeps it all in equilibrium. It does this by quickly and flexibly accepting offers from companies participating in the electricity generation, procurement and demand reduction market.
Essentially, this process ensures that the amount of power produced is equal to the amount of power required at any given time.
How does balancing the system work?
Every half an hour, a calculation is made between the contracted and actual amounts of electricity that a company has produced or consumed. If supply and demand don’t match, National Grid will address the disparity via the Balancing Mechanism.
If the system is ‘short’ (i.e. the demand for electricity exceeds supply), the systems operator will accept more offers to either increase generation or reduce demand. And if the system’s long (i.e. electricity generation exceeds potential demand), it will accept more bids to reduce generation output or increase demand. National Grid accepts these bids and offers (or ‘balancing actions’) in the most economic and efficient manner possible.
The final ‘imbalance’ price (also known as the ‘system price’) is the same as the most expensive 1MWh of the netted-off balancing actions taken.
What are day-ahead prices?
The trading of electricity on the ‘day ahead’ market involves sellers (typically, generators) and buyers (typically, suppliers) agreeing contracts for the delivery of power the following day. These trades can take place directly (or “over the counter” - OTC) or through energy exchange auctions such as the Nord Pool N2EX.
A supplier will decide how much power it needs to purchase for the day-ahead, and the price it’s willing to pay. The generator will decide how much power it can deliver, and the price. Every day, the auction reflects these requirements through orders from the buyers and sellers.
The final price of the auction will depend on the demand from suppliers and the prices submitted by generators. If the demand is low, the auction will clear at a lower price because cheaper offers from generators have met the bids. As demand increases, the auction price rises.
Most businesses see electricity as a cost. However, an increasing number are taking advantage of the opportunity to trade their self-generated electricity on both the wholesale and day-ahead markets. Could this approach boost your company’s balance sheet too?
To learn how the energy markets can impact third-party costs on your electricity bill, watch our video by Johnny Ball: