Energy supply and demand is hardly something that most people in developed countries think about very often. You can turn the TV on, plug your phone in, heat your water, and mystically you get exactly the power you need instantly. Behind this is an unseen world of power producers, transmission cables and energy markets and that unseen world is rapidly changing.
When I started in the energy industry, I remember wishing I had some quick introduction into electricity markets and how they work. So below is my attempt to fill the gaps for anyone else starting out in the industry.
Background: The energy industry over the last 100 years
How much the energy industry has changed in the past 100 years is almost incomprehensible. It has grown from small generators powering individual factories and homes to huge networks of power lines connected by innumerable electrical systems (transformers.. switches… cables.. what have you). Further behind this, what is less widely understood, is the electricity market. You, as a residential consumer, don’t see this. You get a flat rate for your power – a flat rate which is approximately 10 times the price per kWh of what is sold wholesale. That probably seems unfair – but consider that the other 90% of that price goes towards maintaining the grid that you use and ensuring that you never have to worry about your electricity demands – and trust me, it isn’t something you want to worry about.
The electricity market in general
The electricity market is what connects the large scale power producers to the large scale consumers. Producers are your power plant owners and consumers are large factories or your local distribution operators.
There are usually two parts to this market: the free market, where any supplier/consumer can buy and sell electricity freely (subject to certain market rules), and then a balancing market, which is usually controlled by the national grid operator and is used to ensure grid stability by balancing production with demand.
(Above: Our German trading desk complete with talented traders)
Open vs Closed Markets
First, let’s define some terms. Closed, sometimes referred to as regulated, means, generally, that one entity has a monopoly on your electricity: from the power plants to distribution to your home. This system is arguably much simpler. The problem that I see is the same problem with most monopolies: There is no competition, and competition leads to incentivizing a better product. What can make electricity a better product? Lower prices is the obvious one here. Sustainability plays a large role as well. Some consumers will want their electricity to come from renewable sources, which is generally less transparent and more difficult in regulated markets.
Deregulated markets allow independent producers to offer their electricity on a wholesale market. Generally, deregulation has led to lower wholesale prices; California is one example .
Note: ‘Deregulated’ is a misnomer here, commonly used in the industry. It doesn’t mean that there are no regulations, but rather that the market is open to competition.
How Deregulated Electricity Markets Work (Simplified)
Energy markets work almost like any other market, with the exception that electricity is bought and sold for a certain time period, called the delivery period. For example, you can buy 1 MW baseload (running all the time) for Calendar year 2017 in Germany for 24.35 Eur/MWh (At the time I am writing this..) This means, you would pay the anonymous seller 24.35*24*365 = 213,306 Euros, and they would provide you with 1 MW of power from January 1 2017 00:00 to December 31 2017 23:59. This is different than other products such as copper or gold, which once you buy them, you own them, and you can sell them or use them at any time. Electricity is bought and sold for a certain time period, and ONLY that time period. It is also different because usually there is an imbalance price that is paid to the grid operator. For example, you buy this 1 MW of baseload for calendar-2017, but then you actually use 0.8MW baseload. That means there is an extra 0.2 MW being injected into the grid for the entire year, but not being used. If enough people do this, it can cause grid instability. It is the grid operator’s job to ensure grid stability, and he manages this imbalance for you, but then levies the total cost onto you and this is called the imbalance cost. In the end, you ‘pay’* for not only the amount of electricity you used, but also the difference between what you thought you would use, and what you actually used.
*Side note: In this case, the operator would actually pay you, because you used less than you anticipated, but the price they would give you for the 0.2MW would be generally less than you could have gotten selling it wholesale, so effectively, you lost money. For example, let’s say they would pay you on average 15€/MWh for the 0.2MW you injected into the grid, so while you could have gotten 0.8MW baseload for 0.8*24.35*24*365 = 170.644€, you instead paid 24.35*24*365 – 0.2*15*24*365 = 187,026€ )
Intraday electricity trading
Electricity production doesn’t sleep, especially wind production, which is a large part of Statkraft’s renewable portfolio in Europe, and that wind production needs to be traded and balanced. To do this we have teams of 24 hour traders. They ensure that the actual amount of power produced matches what we expected, and their closest friend and nemesis is the forecast. To explain intraday trading, let’s use Germany as an example.
In Germany all power can be sold in 15 minute blocks. It doesn’t matter what your production profile looks like within those 15 minutes, it is just the total amount produced (MWh) that matters.
To put the amount of power we are talking about into perspective. On the German intraday market you cannot sell power in increments smaller than 0.1 MW. Which is approximately 60 dishwashers all running at the same time.
Wind turbines have to sell the amount of power that they forecast they will produce the day before at noon. Later that day, the power for ‘tomorrow’ can be sold intraday (within-day) up until 30 minutes before the delivery period, at which point intraday trading is stopped and you hope that you will produce as much as you said you would. This ‘hope you produce what you said’, as I remember well from my brief rotation in intraday trading, can be very frustrating.
**I should note here, that most intraday traders and analysts (especially the ones we have at Statkraft) are quite good at predicting how the forecast could change, and ensuring that they are prepared for the above scenario. I, however, during my brief time in intraday trading, was not so cool, calm and collected.
Once intraday trading is stopped (30 minutes before delivery), it is up to the grid operator to ensure that enough power is going to be produced to meet the country’s demand (since no one else can buy or sell power anymore). This is done via reserve/balancing markets.
The Balancing Market
The balancing market is used to ensure grid stability. It does this by ensuring that total electricity production meets the total demand. As described above, it isn’t always the case that people use as much electricity as they bought, or sell as much electricity as they will produce. When this happens, there is an imbalance, and total production needs to be increased or decreased to meet this imbalance, so the grid operator may tell certain producers to increase or decrease production by a certain amount in order to maintain the grid. These producers usually have an agreement with the grid operator in place before hand that stipulates how much time/warning they need before they can increase or decrease production, the total amount they can increase or decrease production by, and what the cost to the operator will be. These producers are also usually well compensated for taking this action, so it is not a loss to them. Once the delivery period is over and all possible balancing actions have been taken, the grid operator then calculates an imbalance price for that delivery period. This price is normally based on the costs the grid operator incurred in balancing the grid. This imbalance price is then paid by all the participants based on the difference between what they bought/sold and what they used/produced. The goal of this price is to incentivize participants to produce/use exactly what they said they would.
(And so, our hero is saved even though he produced more than he said he would, because the grid itself had too little power (short), so he was inadvertently ‘helping’ to balance the grid, and therefore he is well compensated for it, and can ride off into the sunset secure in the knowledge that he made good money.)
Once the grid operator has balanced the grid for those 15 minutes, it looks at how much each producer said it would produce vs the actual production, and uses this imbalance to pay for the costs it had to pay to keep all those plants just sitting there in case each producer didn’t produce what they said.
So what’s all the fuss about renewables and grid stability
You may know that some countries manage to be almost 100% renewable, such as Norway. You may think, ‘why can’t every country do that?’. The problem is geography. Norway is lucky enough to be filled with natural hills and lakes which are perfectly suited to hydropower plants. Hydropower allows water to be stored and used as necessary. Wind turbines and solar cells cannot do this. They need other solutions to store their energy such as batteries, which are comparatively very expensive (although rapidly decreasing in price).
The problem with running a country completely off of wind and solar production is that sometimes the sun doesn’t shine and the wind doesn’t blow, OR also problematic, is that sometimes the wind blows TOO much, or the sun shines TOO much. This sounds silly, but it has actually led to negative wholesale prices for electricity… . . . Just think about that for a moment. It means being PAID to USE electricity because there is just too much of it on the grid. Both of these problems are a big deal, and they are problems that we need to solve soon. (Why don’t they just shut the turbines off you ask? Sometimes they do. But due to the payment structure for renewables, in Germany they don’t shut them off until prices are VERY negative…. And I think that’s an explanation for another time).
So what does the future hold?
The short answer is – we don’t know. Distributed energy (a battery in every home and a solar panel on every roof) is one possible future, where every man is his own electricity island.
The other extreme is the ’European copper plate’, which is basically the idea that we will be SO interconnected that everyone will use everyone else’s power. When the sun isn’t shining in Germany, maybe it will be in Italy, etc.
My personal view is a mixture of the two, at least for the next 10 years or so. More consumers will become self-sufficient and at the same time, Europe will become on a whole more interconnected. What it will look like in 50 years, is quite blurry for me though. Questions come to mind such as:
Will there even be a grid? This whole grid system is pretty expensive to maintain if everybody is producing their own electricity anyways.
If there is no grid, how would we handle times with extreme weather conditions – long periods with no sun and little wind? After all, winter is coming.
How can we keep the grid stable with wind and solar producing however much they want, whenever they want? What storage technologies will prevail? Batteries? Compressed air? Hydrogen?
These questions are what make this industry exciting, they are also what make it difficult right now. You can feel it as you walk into the offices. No one – not even the strategists – would tell you they know what the future will hold, especially with these two seemingly conflicting futures: Isolationism and the Copper Plate. We are all waiting to see what will happen and working hard to ensure we are on top of the changes that are to come.
How do YOU think the energy industry will develop? In 5, 10, 30 years? Leave a comment below and let’s discuss!
Feeling self-conscious? E-mail me and we can discuss that way. Roberta.firstname.lastname@example.org