Electricity is typically measured by kilowatt hour (kWh). For example, an electric heater rated at 1000 watts operating for one hour consumes one kWh of electricity. Turning on a 50-watt light bulb for 20 hours uses one kWh of electricity.

Electricity is a unique tradable commodity because it is not storable. Several characteristics differentiate it from other tangible commodities like crude oil or natural gas:

  • It is completely interchangeable. One megawatt hour (MWh) of electricity produced from coal or natural gas contains the same amount of energy.
  • It must be produced and used simultaneously. Electricity storage is still prohibitively expensive. Supply must meet demand exactly in the power grid.

The Power Grid

Independent System Operators (ISOs) and Regional Transmission Organizations (RTOs) are responsible for keeping the power grid balanced between generation and load.

ISO/RTOs will forecast and schedule generation to ensure that sufficient generation and back-up power is in place to meet unexpected demand or generation loss. ISO/RTOs must be non-commercial organizations, neutral and independent of commercial players.

Currently there are nine ISO/RTOs in North America. Each one is responsible for the reliability, operations, resource planning and expansion in the deregulated electricity market region in North America:

  • Alberta Electric System Operator (AESO)
  • California independent system operator (CAISO)
  • Electric Reliability Council of Texas (ERCOT)
  • Midcontinent Independent System Operator, Inc. (MISO)
  • ISO New England (ISO-NE)
  • New York Independent System Operator (NYISO)
  • Ontario Independent Electricity System Operator (IESO)
  • PJM Interconnection (PJM)
  • Southwest Power Pool (SPP)

View a map of ISOs and RTOs.

Each ISO/RTO typically operates energy, capacity, financial transmission rights and ancillary services markets.

Short Term Market

For short term power grid reliability and resource scheduling, ISO/RTOs provide a forward energy market for participants. This market typically consists of day-ahead and real-time markets.

Electricity generators and load serving entities submit their bids to ISO/RTOs in the day-ahead market to receive or offer electricity to the power grid based on varying costs for each hour of the next operating day. ISO/RTOs optimize the generation dispatch schedule considering cost, security and transmission constraints. Market participants will commit to the schedule with a locational marginal price (LMP) set at each location based on published prices from ISO/RTOs.

LMP = System Energy Price + Transmission Congestion Cost + Cost of Marginal Losses

In deregulated regions, the electricity wholesale market starts and centers around the ISO/RTO. Electricity generators and Load Serving Entities (LSE) submit their generation offers and load bids in the day-ahead and real-time market.

Supply and Demand

System operators balance electricity supply and demand in each location on the bus considering the transmission constraints through an auction process:

  • ISO/RTO predicts hourly demand.
  • Generator places offers at specified prices, which are often based on the cost of operation.
  • ISO/RTO sorts the offers in an ascending order to determine available supply at different price points.
  • ISO/RTO selects the lowest-priced combination of offers required to meet the demand.

The clearing price is based on the marginal unit of the generator’s offer price. Given the below generation options, if the capacity required is 3200 MW, the clearing price set by marginal unit would be $50/MWh.

Generation Offer Capacity (MW) Price ($/MWh)
Wind Farm 50 0
Solar 70 5
Nuclear Plant 2000 25
Gas Combined-Cycle 1000 40
Coal 500 50
Demand Response 100 100

In the real-time market, operators send dispatch instructions to each generator based on actual system operating conditions in real-time.

Long Term Market

For longer term grid resource stability, ISO/RTOs operate a capacity market that auctions the commitment of a resource to provide energy during a system emergency under the capped energy price. Revenues are paid regardless of whether energy is produced or not.

CME Group offers a variety of futures and options contracts for electricity day-ahead, real-time and capacity market participants in various regional locations to hedge and manage risk exposure.

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Did you know that CME Institute classes can fulfill CFA and GARP continuing education requirements? Every CME Institute course can be self-reported in your CFA online CE tracker and select classes can be used for GARP credits. See which of our classes qualify for GARP credits here.

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