Energy Markets 101:  Deregulated Market Operation 

Understanding the basics of how deregulated energy markets operate is key to navigating the complexities of modern energy procurement. Deregulated energy markets operate somewhat like auctions. Producers offer their generation into the market at cost, and wholesale consumers submit bids to meet their forecasted demand. The market operator, an ISO or RTO, uses this information and an optimization model to determine which operators will generate power and for what price.   

In deregulated electricity markets, prices can be determined either a day in advance or in real time. Deregulated markets tend to do both, with day-ahead transactions setting the stage for real-time rebalancing and operations.  

Day-ahead   

The day-ahead market is a financial market which involves scheduling and pricing electricity one day before the actual delivery. Market participants, such as generators and large consumers, submit bids and offers to the market operator, who then determines the optimal dispatch of resources based on predicted demand for the following day. Bids submitted into the day-ahead market are considered binding, meaning the buyer must buy and the seller must sell at the price submitted. The prices set in the day-ahead market reflect the estimated supply and demand conditions for each hour of the next day, providing a forward-looking view of energy costs.  

Key features:  

• Predictability: Day-ahead prices offer more predictability, allowing market participants to plan generator dispatch and hedge against price fluctuations.  
• Risk management: By locking in prices a day in advance, participants can manage their exposure to volatile real-time prices.  
• Basis for real-time market: The day-ahead market sets a foundation for real-time pricing, providing a benchmark against which real-time prices can be compared.  

Real-time   

The Real-time market occurs much closer to the actual time of delivery of electricity. Prices in this market are determined in real-time based on actual demand and supply conditions and typically run in five, fifteen, or sixty-minute intervals. This market is crucial for balancing supply and demand on a minute-to-minute basis, responding to unforeseen changes such as unexpected weather events, generator and transmission outages, or sudden spikes in demand.  

Key features:  

• Flexibility: Real-time prices reflect the true cost of electricity at any given moment, providing the most accurate picture of current market conditions.  
• Volatility: Real-time prices can be highly volatile, fluctuating significantly due to sudden changes in supply or demand.  
• Essential for balancing: The real-time market ensures that the grid remains balanced by adjusting prices to incentivize immediate changes in generation or consumption.  

Interaction between day-ahead and real-time markets  

The day-ahead and real-time markets work together to ensure the reliability and efficiency of the electricity grid. While the day-ahead market provides a plan based on forecasts, the real-time market adjusts for actual conditions. Discrepancies between the two can result in price differences, known as “imbalances,” which market participants must manage. For example, if actual demand is higher than anticipated in the day-ahead market, real-time prices may spike to incentivize additional generation or reduce consumption. Conversely, if demand is lower than expected, real-time prices may drop, potentially leading to negative pricing in extreme cases.  

Ancillary markets  

Ancillary markets play a crucial role in maintaining grid reliability in deregulated markets, where financial mechanisms are used to manage grid operations that would otherwise be handled by vertically integrated utilities. These mechanisms are collectively known as ancillary services, and while each organized market (ISO/RTO) may have its own terminology and subcategories, they generally fall into two main categories: reserves and regulation. 

Reserves services involve generators being on standby to provide extra power when needed. There are two types: 

• Spinning reserves: Traditionally provided by thermal generators operating below full capacity, ready to ramp up when required. More recently, batteries and flexible loads have become viable providers in these markets. 
• Non-spinning reserves: Provided by resources that can deliver power within a few minutes when called upon, though the response time depends on the specific market's requirements. 

Regulation services help fine-tune the balance between supply and demand in real time, compensating for minor fluctuations to maintain grid frequency. These services are sometimes divided by response time or the ability to increase or decrease output. Renewable energy sources like wind and solar can participate by curtailing output, as they are typically already producing at full capacity based on weather conditions and cannot easily increase production. 

In the late 2010s, FERC mandated that ancillary markets must be technology-neutral, requiring RTOs and ISOs to ensure that all types of resources could participate if they were physically capable. However, market rules differ across regions, making it important for participants to understand local regulations before entering these markets. 

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