Electricity Markets

A Comprehensive Exploration of the Spanish (and Broader European) Electricity Market

Electricity markets in Spain—and throughout Europe—operate through a series of auctions and mechanisms that progressively refine the balance between supply and demand, from the day before delivery all the way to real-time. This step-by-step chain includes day-ahead auctions, intraday adjustments, balancing (reserve) services, and final imbalance settlements. While the day-ahead and intraday markets establish baseline and updated schedules, the balancing (or ancillary) services ensure system stability in real time. Although each segment is distinct in timing and pricing methodology, they interlock to form a coherent system. Below is an in-depth exploration of how they work, why different price signals exist, and how market participants—from power generators to retailers, large consumers, and traders—navigate these opportunities.

1. Market Structure and Timeline

1.1 Day-Ahead Market (D-1)

The day-ahead market is the foundational auction through which most energy is bought and sold. In Spain, this auction is administered by OMIE and typically closes around midday on the day before physical delivery (D-1). Producers, retailers, large consumers, and traders submit bids and offers for each hour of the following day (D). The system uses a marginalist mechanism: every hour’s price is set by the highest-cost accepted offer needed to satisfy demand at that hour.

This market serves as the principal reference for electricity prices. It is generally less volatile than real-time mechanisms, since it captures the best forecasts available one day in advance. However, significant changes in demand (e.g., extreme weather events) or unexpected supply constraints (e.g., generator outages) can cause the day-ahead price to spike.

1.2 Intraday Trading (Auctions and Continuous)

After the day-ahead auction closes, market participants often need to adjust their positions due to new forecasts or unexpected events. Spain historically employs multiple intraday auctions—up to six in a typical day—allowing refinements to the day-ahead positions. These sessions use a marginalist approach similar to the day-ahead market, but they occur progressively closer to real-time.

Once the final intraday auction concludes, continuous trading takes over, typically up to about one hour before delivery. In this continuous market, buy and sell orders are matched instantaneously on an electronic platform. Prices here can be more volatile than at earlier stages, reflecting the market’s response to last-minute changes—such as wind forecasts shifting or a sudden industrial consumption spike.

1.3 Balancing Services and Real-Time Operations

Even after the intraday market closes, the system operator (Red Eléctrica de España, or REE, in Spain) has ultimate responsibility for balancing supply and demand in real time. To maintain frequency and reliability, REE relies on several ancillary services:

• Secondary Reserve (aFRR): Automatically adjusts generation or consumption within minutes to correct frequency deviations.

• Tertiary Reserve (mFRR): Manually dispatched if secondary reserve is insufficient or if imbalances persist; typically activated within minutes to half an hour.

• Imbalances (Ex Post Deviations): After the fact, participants’ actual generation or consumption is compared to their scheduled nominations. Any shortfall or surplus is settled through an imbalance price, which is often punitive compared to proactive correction in the intraday market.

Balancing services ensure that any deviation from the schedule—even minutes or seconds before real-time—is quickly addressed, preventing large-scale frequency or voltage problems.

2. Price Formation and Cost Dynamics

2.1 Comparing Day-Ahead, Intraday, and Balancing Prices

Prices tend to increase as one moves closer to delivery because the ability to respond on short notice requires flexibility. The day-ahead market offers relatively stable price signals, while intraday auctions and especially continuous trading can exhibit sharper movements as new information emerges. Balancing services, by design, command higher remuneration for quick or automated responses. The further in advance an agent corrects its position (i.e., in day-ahead or intraday), the lower the likely cost of alignment.

2.2 Imbalances as a Costly Last Resort

When a market participant’s actual generation or consumption differs from the scheduled plan, the resulting imbalance is settled at the imbalance price. This mechanism is deliberately set to be less favorable (sometimes significantly so) than voluntary market trading, incentivizing accurate forecasting and proactive position management. Whether an agent ends up paying or receiving depends on whether the system as a whole needs additional energy (short system) or has excess (long system).

3. Participation of Different Market Agents

3.1 Generators and Large Consumers

Generators typically sell the majority of their output in the day-ahead market, adjusting in subsequent intraday sessions if forecasts or operational constraints change. Large consumers (e.g., industrial facilities) may similarly purchase the bulk of their electricity in day-ahead, fine-tuning their positions intraday. Both generators and consumers can offer balancing services if they meet the technical requirements set by the system operator.

3.2 Retailers and Traders

Retailers buy power on behalf of their end customers and must ensure the aggregate offtake matches those customers’ consumption patterns. Traders, on the other hand, may buy and sell electricity to arbitrage price differences across different markets (for example, day-ahead vs. intraday) or across different geographies. In balancing services, participation generally requires specific technical capability, so traders often have a more limited role unless they have dispatchable assets or demand-response portfolios.

4. Focus on Balancing Services: Secondary and Tertiary Reserves

Balancing services in Spain (and across many European countries) ensure that the system can respond quickly and effectively to sudden fluctuations. Although they are collectively known as “reserves,” they involve two distinct components for each participant:

1. Offering Reserve Capacity (being available if called upon).

2. Supplying or Withholding Energy (when activated).
   
   

4.1 Reserve Capacity Tenders: Marginal Auction

Spain uses marginal auctions to secure reserve capacity for both secondary (aFRR) and tertiary (mFRR) reserves. Here, market participants submit offers indicating how many megawatts (MW) they can provide and at what price per MW of availability. The system operator accepts the most economical offers until the required volume is reached. All successful bidders then receive the marginal price—the rate offered by the most expensive accepted bid. If, for instance, you offer capacity at 50 €/MW and the marginal clearing price ends up at 60 €/MW, you receive 60 €/MW for that capacity, regardless of your original lower offer.

4.2 Activation of Energy: Pay-As-Bid

Once the capacity is secured, REE only calls upon the energy from those providers if and when it is needed (e.g., a drop in system frequency or a sudden imbalance). The pricing structure for energy activation in Spain typically follows a pay-as-bid model. This means each provider is paid exactly the price they offered for the MWh delivered, rather than a uniform marginal price. If you bid 200 €/MWh for activation, and you are selected, you receive 200 €/MWh, irrespective of whether another provider had a higher or lower price.

Order of Activation
When an imbalance arises, REE activates resources starting with the lowest-cost offers first, moving upward until the required volume is obtained. Thus, although each provider is paid according to its own bid, the order in which they are activated depends on the relative attractiveness of their offer.

Strategic Implications
Generators or large consumers offering balancing services therefore have an incentive to keep their capacity bids low (to ensure selection) while balancing their desire for higher energy-activation prices against the risk of not being activated if the price is too high. This dynamic encourages a careful optimization of capacity and energy bids, reflecting both the likelihood of being called and the potential revenue from pay-as-bid activation.

5. Capacity Markets for Long-Term Security

In addition to day-ahead, intraday, and balancing mechanisms focused on daily or hourly operations, capacity markets exist to ensure there is enough generation and flexible demand to meet peak loads over longer horizons. These markets may involve annual or multi-year auctions through which generators (existing or new) commit to being available, and in return, they receive a fixed payment per MW of installed capacity. Such mechanisms can also include large industrial consumers capable of demand response. Participants who fail to deliver during critical periods typically face penalties, aligning their financial incentives with the physical reliability needs of the grid.

6. Imbalances and Settlement Ex Post

After real-time, each participant’s actual generation or consumption is measured, and any deviation from the nominated schedule results in an imbalance. The price associated with these imbalances can be more punitive than in the voluntary markets. For instance, if the system operator had to activate expensive tertiary reserves to cover a shortfall, participants who under-produced (or over-consumed) might pay an elevated imbalance price. Conversely, those who over-produced in a short system could be compensated, but again, the price is set by system conditions and rules, typically making it more expensive to rely on the imbalance mechanism than to adjust in earlier markets.

7. Observations

1. Early Alignment Saves Costs.
The earlier a participant corrects its position—be it in the day-ahead or intraday markets—the cheaper it generally is. Intraday auctions and continuous trading help refine positions, but waiting until real-time balancing or relying on imbalances can be costly.

2. Flexibility Commands a Premium.
Balancing services, particularly secondary and tertiary reserves, offer higher remuneration to those capable of rapid or automated responses. This premium reflects the technical requirements and the value placed on system stability.

3. Distinction Between Capacity and Energy Pricing.
Spain’s two-tier approach—marginal pricing for reserve capacity, pay-as-bid for activation—can lead to different bidding strategies. Offering a low capacity price boosts the chance of selection, but a high energy activation price may reduce the likelihood of dispatch.

4. Long-Term Adequacy Through Capacity Mechanisms.
Separate auctions ensure sufficient generation (and responsive demand) in the medium to long term, safeguarding the grid against shortfalls during peak demand or unforeseen outages.

By comprehending these various layers—day-ahead scheduling, intraday refinements, real-time balancing, and final imbalance settlement—market participants can optimize both their operational and financial outcomes. These mechanisms, though intricate, align well with the ultimate goal of delivering reliable electricity at least cost, while incentivizing the flexibility and innovation needed in a rapidly evolving energy landscape.