Electricity Markets

A Comprehensive Overview of the Electricity Market

Below is a structured, step-by-step guide to understanding how electricity markets operate, using Spain as a primary reference but noting that similar principles apply in other European markets. Our aim here is twofold:

1. Educate readers on the key “windows” of negotiation for buying and selling electricity.

2. Demonstrate how different services—day-ahead, intraday, balancing, and capacity—fit together in a timeline that spans from the day before delivery all the way to real-time operation and beyond.

This framework helps clarify why prices and costs vary depending on how close we get to the actual delivery of electricity, and how different participants (generators, retailers, large consumers, traders, etc.) engage in each segment.

The Market Timeline

Day-Ahead Market (D-1)

• When? Conducted the day before physical delivery. For instance, for energy to be delivered on day “D,” the day-ahead market closes on day “D-1.”

• Purpose: Establish a base schedule for generation and consumption for every hour of the following day.

• Pricing: Formed by matching supply and demand bids in a marginalist auction (in Spain, this takes place on OMIE). It typically serves as the main price reference for the industry.

Intraday Auctions (D-1 to Just Hours Before Delivery)

• When? Multiple auction sessions throughout the day (historically six in Spain).

• Purpose: Allow market participants to adjust their positions after the day-ahead market closes, covering forecast errors or unexpected changes in demand and supply.

• Pricing: More volatile than day-ahead, as these auctions reflect shorter-term adjustments.
  
  

Intraday Continuous Trading (Up to ~1 Hour Before Delivery)

• When? Continuous trading begins once the intraday auctions have closed and runs until roughly one hour before real-time.

• Purpose: Final opportunity to fine-tune positions close to real-time, factoring in last-minute changes (e.g., weather shifts, technical outages).

• Pricing: Often even more volatile, given how close it is to delivery and the immediacy of any market imbalance.
  
  

Real-Time and Post-Real-Time Balancing Services

• Secondary Reserve (Automatic Frequency Restoration Reserve): Activated automatically to maintain system frequency and balance. It replaces depleted reserves within minutes.

• Tertiary Reserve (Manual Frequency Restoration Reserve): Manually dispatched if secondary reserve is insufficient or a shortfall persists. Activation ranges from minutes to half an hour.

• Imbalances (Deviations): Settled ex post for any discrepancy between the scheduled (nominated) energy and what was actually produced or consumed.
  
  

Balancing services are managed by the System Operator—in Spain, this is Red Eléctrica de España (REE).

Price and Cost Comparisons

Day-Ahead Market

1. • Acts as a baseline for prices.

   • Typically less volatile, although it can experience spikes when supply-demand dynamics are tight.
     
     

Intraday (Auctions and Continuous)

1. • Generally more volatile than day-ahead.

   • Prices can be higher or lower than day-ahead, depending on real-time needs and forecast adjustments.

Balancing Reserves (Secondary, Tertiary, etc.)

1. • Designed to maintain system stability in near real-time.

   • Higher costs for activated energy, as providers must offer rapid, flexible response.

   • Include payments for availability (“capacity”) and payments per MWh actually activated.
     
     

Imbalances (Ex Post Deviations)

1. • Charged or credited after delivery, depending on how an agent’s actual production/consumption compares to what they had scheduled.

   • Typically the most expensive way to correct mismatches, reflecting a penalty for poor forecasting.

Key Takeaways

• Early Correction is Cheaper: The further in advance you correct your position (day-ahead or intraday), the lower the cost.

• Rapid Response is Priced Higher: Balancing services (secondary, tertiary) cost more because they require fast (and sometimes automated) responses to sudden system imbalances.

• Imbalances are Costly: Deviations from your scheduled plan can be penalized significantly, emphasizing the importance of accurate forecasting.

• Direction and System Conditions Matter: Upward/downward regulation or a surplus/shortfall of energy in the system can affect pricing. Typically, delivering additional energy into a short system is more expensive.

How Different Agents Participate

The following sections detail the mechanisms and opportunities for generators, retailers (commercializers), large consumers, and traders in each market segment.

Day-Ahead Market

• Who? Generators offer electricity for sale; retailers and large consumers buy on behalf of end-users; traders participate for arbitrage or portfolio balancing.

• When & How? A single daily auction around midday (in Spain, ~12:00 on D-1) sets prices for each hour of the next day.

• Price Formation: Marginalist system—each hour’s price is determined by the last (most expensive) accepted offer needed to meet demand.

• Remuneration: Sellers get the marginal price × MWh sold; buyers pay the same marginal price.
  
  

Intraday Auctions

• Who? The same set of market participants who need to modify their positions after the day-ahead market.

• When & How? Several discrete auction sessions occur throughout the day.

• Price Formation: Also marginalist, but closer to real-time, hence more volatility.

• Remuneration: Prices can differ from (and sometimes exceed) day-ahead prices, reflecting unexpected swings in supply or demand.
  
  

Intraday Continuous Market

• Who? Primarily generators and retailers further adjusting positions, plus traders seeking short-term arbitrage.

• When & How? Runs continuously from the close of the last intraday auction until roughly one hour before delivery.

• Price Formation: Based on immediate matching of buy/sell orders (order book).

• Remuneration: Each transaction is settled at the agreed price at the time of matching; can be highly volatile.
  
  

Balancing Services

Includes secondary reserve, tertiary reserve, and other ancillary services:

Secondary Reserve

• Objective: Automatic, near-instant correction of small frequency deviations.

• Who? Generators or large consumers with the technical capability for quick, automatic response.

• Price Formation: There is typically a payment for availability (reserve capacity) plus an additional payment when the service is actually activated.

• Remuneration: Higher than normal market prices due to the premium for immediate response.
  
  

Tertiary Reserve

• Objective: Manually activated to address larger or more prolonged imbalances.

• Who? Units able to ramp production or cut consumption within minutes.

• Price Formation: Similar to secondary reserve—offers are submitted, and capacity is awarded in order of economic merit.

• Remuneration: Generally still above day-ahead or intraday levels, though often slightly below secondary reserve pricing.
  
  

Capacity Market

• Objective: Ensure enough generation and/or controllable demand to meet peak load and system reliability requirements in the medium/long term.

• Who? Generators (existing or new) and large flexible consumers.

• When & How? Periodic auctions (possibly annual or multi-year) to lock in availability commitments.

• Remuneration: Usually a fixed payment per MW of capacity provided, with potential penalties if participants fail to deliver during critical periods.
  
  

Imbalances (Ex Post Deviations)

• Objective: Final financial settlement for the difference between scheduled (nominated) and actual production/consumption.

• Who? Any agent holding a position in the market.

• Price Formation: Based on imbalance pricing rules set by the System Operator—often higher (when additional energy is needed) or lower (when the system is oversupplied).

• Remuneration/Penalty: Agents pay or receive funds according to whether their imbalance helped or hurt the system. Prices tend to be punitive compared to intraday trading.

Final Observations

1. Proactive Strategy: Engaging in the day-ahead or intraday markets to minimize imbalances generally leads to cost savings.

2. Flexibility Pays Off: Services like secondary or tertiary reserves offer higher remuneration because they help stabilize the grid in real-time.

3. Long-Term Security: Capacity mechanisms exist to ensure investments in generation and demand-side resources, maintaining sufficient reserve margin.

4. Operational Requirements Vary: Each market segment has its own technical and regulatory criteria, overseen by the Market Operator (OMIE in Spain) and the System Operator (REE in Spain).
   
   

By understanding and navigating these market layers—from early scheduling to real-time balancing—participants can optimize costs, support grid stability, and seize opportunities in an increasingly dynamic energy environment.