We all consume energy in various forms, but how many of us know exactly where it comes from?
Or more importantly, how it gets traded and transported…
The Wholesale Electricity Market – What is it?
At its most basic, electricity is a commodity like any other that can be bought, sold, and traded. The wholesale energy market is the platform in which electricity can be bought and sold by power producers and retail companies.
During the 1990s, the energy markets in the United States underwent severe deregulation – leading to the creation of the wholesale market. The price for each unit of wholesale electricity can vary massively at any given instant, with the prices updated regularly. The mechanism for price determination is like any other deregulated market – supply and demand interactions. As such, the price can for electricity be shifted massively by things like weather conditions, price of fuel used, resource availability (like wind and sunlight). For the most part this offers an advantage over regulated markets through lower prices, better price transparency, and improved grid reliability.
The Wholesale Electricity Market – How does it work?
Power producers – either utility companies or independent power producers – will produce electricity to sell on to their local electricity wholesale market. From here, the electricity for sale is then shown on electricity trading platforms and can be purchases by retail electricity suppliers and others such as financial intermediaries, energy traders, or even directly by large consumers. In the United States the wholesale platforms are divided geographically between ISOs and RTOs (Independent System Operators and Regional Transmission Organisations).
ISOs and RTOs – What are they?
The trading of electricity is absolutely necessary for grid stability across the US and is able to be bought or sold between states. To achieve this, reliable electricity transmission infrastructure is obviously imperative.
The wholesale markets are organised mostly by Independent System Operators (ISOs) or Regional Transmission Organisations (RTOs), who are responsible for the transport of electricity between states. They will also offer a trading platform for buying and selling electricity.
However, to differentiate between the two is actually incredibly difficult. They both do the exact same thing – operate a region’s electricity grid and manage regional wholesale electricity markets. One slight difference is that RTOs assume a larger share of responsibility for the transmission network.
The US Interstate Wholesale Markets
For both the US and Canada, the interstate wholesale electricity markets are coordinated by ISOs. ISOs in the US include:
- PJM
- ERCOT Market
- New York Market
- Midwest Market
- California ISO
- New England Market
- Southwest Power Pool
Each of these organisations have their own trading platforms on which buyers and sellers can connect with one another and make transactions. Wholesale energy markets in the US are under the jurisdiction of the Federal Energy Regulatory Commission (FERC).
Wholesale and Retail Electricity – What is the difference?
The largest difference is in price, wholesale electricity is usually much lower than the price of retail electricity. This is since the price of retail electricity includes additional charges to purchase, and then deliver it to consumers.
Depending on what US wholesale market region observed, the wholesale price of electricity was on average between 3.8 ¢/kWh and 6.6 ¢/kWh. In contrast, average retail prices in the same year (2013) were 11.72 ¢/kWh – between 2 to 3 times higher.
Retail electricity bill breakdown:
- Wholesale Price – 35%
- Purchasing Cost – 5%
- Delivery – 45%
- Taxes and State Surcharges – 15%
Wholesale and Retail Electricity – Why are they different?
There is a clear price difference between wholesale and retail electricity, and as already alluded to – this is because of the addition of some premiums. For the retailers who take on the risk of purchasing power and then organising the delivery to customers, there must be a benefit for them to do so. This is reflected in the price they sell electricity for.
Add on sales taxes and state charges like low-income assistance and renewable energy incentives and you then have the retail price for electricity.
Why does price not vary proportionally?
When wholesale electricity prices are falling – do retail prices do the same?
Not necessarily – as the two are linked, but not entirely. Retail electricity is not always purchased entirely from wholesale markets, and can come from the following sources too:
- Over the counter (OTC): Usually these are deregulated and offer both standardised and customised products (tailored to the needs of customers). Over the counter transactions are anonymous and therefore difficult for market authorities to monitor.
- Power exchange (PX): Usually these are regulated transactions and are heavily standardised. These are subject to intense surveillance from energy market authorities like FERC.
In markets not open to competition, utility companies will commonly own their own power generation plants. The price of electricity is then regulated by the state’s Public Service Commission – leading to less variety in price than on wholesale markets.
Federal Energy Regulatory Commission (FERC) – What do they do?
The FERC is a United States federal agency holding authority over US energy markets. This includes:
- Regulation of wholesale markets in the US, ensuring the transitions between buyers are sellers are done legally. For regulated regions the FERC regulates the prices of electricity sold on the wholesale market, ensuring that prices are fair.
- Reviewing any mergers and acquisitions of any electricity companies. This is to avoid the events of any monopolies forming – which is closely monitored by the FERC.
- Ensuring the reliability of the electricity grid. The FERC demands reliability standards to be adhered to so that blackouts and other technical issues are minimised.
- Permitting hydroelectric plants – ensuring that these installations are legal from an ecological point of view.
- Handling permissions for the construction of new transmission lines – in some cases, transmission line projects require approvals on siting applications.
- Also fulfils the same roles in the gas and petrol markets.
Relationship with State Public Utility Commissions
Any questions regarding regulations specific to your state should likely be directed to your state public utility commission rather than the FERC. This is because FERC does not handle any decisions taken at a state level – including:
- Retail electricity: Laws relating to retail energy suppliers will differ between states, the FERC may not help if there are issues arising with an alternative supplier.
- Power plants: The FERC does not hold much authority over the construction of power plants, this is more the duty of public utility commission.
- Distribution lines: These are managed by the states’ public utility commission.
The History of the FERC
In 1930, in order to manage hydroelectric plants at a federal level the Federal Power Commission (FPC) was formed. Following on from this in 1935, the FPC then became an independent regulatory agency – meaning that it was not under presidential control. They also then began to regulate interstate electricity in the same year.
In 1938, natural gas was also included under the FPC’s authority. Then, in 1973 because of the oil crisis the Department of Energy was created. It was important that the energy commission remains independent from the Department of Energy – resulting in the Federal Energy Regulatory Commission (FERC) being created.
The Energy Policy Act of 2005 then gave more authority to the FERC in regulating electricity and gas markets. Among some extra responsibilities, the Act also gave the FERC authority to fine companies for manipulation of the electricity and gas markets.