Markets of electricity vs other products
The development of electricity markets is based on the assumption that electricity can be treated as a product and obeys the relevant theories regarding the demand and supply curves.
But if electricity was a simple product, kilowatt hours would be on shelves just like apples and pears, ready for consumption when the consumer turns on the light. So that is why, the analysis is far more complex as there are significant differences between electricity and other products. These differences have a profound impact on the organisation and rules of electricity markets.
The main difference is that electricity is connected to a complicated natural system that operates much faster than any other market. In this natural electrical system, supply and demand, production and consumption must be balanced on a per second basis. If this balance is not maintained, the electrical system collapses with disastrous consequences. Such an interruption is unacceptable as it does not only interrupt the trading system but also a whole region or even a country can be left without electricity for several hours.
Restoring an electrical system to its normal operation after a complete collapse is a very complex process and can take up to 24 hours or even more in major industrial countries. The social and economic consequences of such a widespread disruption in the operation of electrical systems are so intense that no reasonable national energy regulator and / or government would agree to the implementation of a simplified electricity purchasing mechanism that would significantly increase the likelihood of such an event.
Thus, the reliability of the electrical system has two aspects: (a) adequacy, that is the ability of the system to meet the requirements of its customers in both electrical capacity and energy, and (b) safety, the ability of the system to remain in operation after sudden disturbances that may occur. Today, the reliable supply of specific quantities of electricity requires large power plants connected to consumers via transmission and distribution networks.
An equally important but less fundamental difference between the electricity market and those of other products is that the energy generated by a generator cannot be directed to a specific consumer. And vice versa, a consumer cannot receive energy from just one generator. Instead, electrical energy produced by all generators is concentrated in the course of consumption. This concentration is possible because the units of electric energy generated by different generators are similar. Concentration is desirable because it leads to significant energy savings. Maximum production capacity should be proportional to maximum aggregate demand rather than total maximum individual requirements. On the other hand, an interruption in a system where products are concentrated has an impact everywhere and not just on parties involved in the transaction.
Given that it is currently not economical to store large amounts of electricity, this energy should be produced around the same time it is consumed. Therefore, electricity traders always refer to a certain amount of kilowatt-hours sold during a certain period of time. The duration of this time period is typically set to one hour, half an hour or a quarter of an hour depending on the country or region where the market is located. Since electricity sold during a period is not the same product as electricity sold during another period, the price will usually be different for each period.
Finally, demand for electric energy reflects predictable daily and weekly cyclical changes. However, it is not the only product for which demand is cyclical. For example, coffee consumption has two or three spikes every day and periods of lower demand. Coffee trade does not require special mechanisms because consumers can easily store it in solid or liquid form. On the other hand, electricity must be produced at the same time it is consumed.
Since short-term price volatility is extremely short, balancing production and demand requires production facilities that are capable of adapting to the large and rapid changes in consumption that occur over a day. Not all units will be producing during a 24-hour period. When demand is low, only the most efficient units are likely to be competitive and all others will be shut down temporarily. Feed from less efficient units is only needed to feed at the peak of demand. As the mix of power plants changes following the fluctuations in consumption, the cost of electricity generation changes over the course of the day. Sharp cyclical changes in the cost and price of other products are very unusual.
In conclusion, given the complexity of the electricity market, as well as the reliability of an electrical system for uninterrupted supply to consumers, no matter how much we would like to simplify market rules governing the electricity market, the result will always be complex.
Dr. Andreas Poullikkas is President of the Cyprus Energy Regulatory Authority (CERA)