The Dutch electricity sector - part 2: How do the different electricity markets work?

This article considers the various players in the electricity sector. In the previous article of this series, we described them in detail. The table below summarizes their roles.

Although we often talk about "the" electricity market in colloquial language, there are different markets on which electricity is traded and price formation takes place. We can distinguish three types of markets: wholesale markets, balancing markets, and the congestion market.

Wholesale markets

In the Netherlands, there are three types of wholesale markets on which electricity is traded: the forward and futures market, the day-ahead market and the intraday market (see figure 1). Producers, suppliers, Balance Responsible Parties (BRPs), and large electricity consumers all operate on these markets.

Forward and futures market

On the forward and futures market, electricity is traded with a delivery date up to several years in the future. The further into the future, the less liquid[1] the market. The forward and futures market is important for large generators, large-scale consumers[2] suppliers, and balance responsible parties (BRPs). Because this market gives them the opportunity to produce or purchase a certain volume of electricity at a pre-agreed price. This creates financial security. Two different products can be distinguished here, namely futures and forwards. Futures are standardized contracts that are traded openly via trading platforms ICE Ende x and EEX. Trading takes place in fixed blocks, in which the supply of a certain amount of electricity for, say, a year, a quarter, or a month is agreed upon at a certain price (in euros per MWh). Forwards are not standardized and are traded bilaterally or over-the-counter (OTC). Power Purchase Agreements (PPAs) are one example of this.[3] Many solar and wind farms sell much of their future production as far as ten to fifteen years in advance, using this method.

Day-ahead market

Parties trade mainly “on paper” on the forward and futures market, but on the day-ahead market, supply and demand actually meet. On this market, participants can specify how much electricity they want to buy or sell at a certain price for the next day's 24 hours, via a blind auction in blocks of one hour. This creates so-called bid curves based on marginal costs. Parties can submit bids until noon on the day before delivery. At that time, the auction closes, and the intersection of supply and demand determines the electricity price and volume for each hour.[4] The most expensive plant deployed sets the price (see figure 2). This is the price that all successful auction participants then receive or pay. This mechanism is called marginal pricing.

Larger volumes are traded in the forward and futures market than in the day-ahead market (about 260 TWh versus about 50 TWh per year), yet the day-ahead market is known as "the wholesale market" or "the electricity market" and the day-ahead price as "the electricity price”. This is because the day-ahead market has a single clearing price that is established shortly before delivery, so this market best reflects the value of electricity during different hours. Day-ahead prices therefore often guide other agreements or arrangements. For example, when determining the amount of subsidy that renewable energy producers receive. In the Netherlands, parties can trade on the day-ahead market through both EPEX Spot and NordPool Spot. Unlike the forward and futures market, the day-ahead market is only open to BRPs.

[1] A liquid market is one with lots of daily activity and active traders.

[2] In the Netherlands, a distinction is made between large-scale and small-scale consumers based on the size of their electricity connection. Small-scale consumers have an electricity connection of up to 3x80 amp. If the connection is larger, the end user falls into the category of a large-scale consumer. In general, households and SMEs have a small-scale consumer connection (households typically have 1x35 amp or 3x25 amp connections), while large commercial enterprises have a large-scale consumer connection. An important difference between small-scale and large-scale consumers is that the latter group, in addition to having a supply contract with an energy supplier, must also enter into a separate transportation contract with the system operator. Without such a contract, no electricity can be consumed or fed into the grid. Small-scale consumers, on the other hand, are automatically entitled to use the electricity grid when they sign a supply contract with an electricity supplier. The term "large-scale consumer" applies to both parties that purchase electricity and parties that (also or only) feed it into the grid. Therefore, even a large-scale solar farm, despite being a producer, falls under the category of a large-scale consumer.

[3] Not all PPAs are concluded on the basis of fixed prices; for example, there are PPAs based on a price index.

[4] Electricity imports and exports can still cause a shift in the bid curves.

Intraday market

A few hours after the day-ahead market closes at noon on the day before delivery, the intraday market opens at 3 p.m. On this market, BRPs can adjust their portfolio up until five minutes before the time of delivery. This may be necessary as (weather) forecasts change, and because it is possible to trade in blocks of fifteen minutes on the intraday market, allowing the profile of the BRP's portfolio to be refined. On the day-ahead market, trading is done in blocks of an hour, whereas BRPs must balance supply and demand on a quarter-hourly basis. Unlike the day-ahead market, the intraday market is not an auction, but a platform where buyers and sellers can find each other to settle bilateral transactions. So there is no uniform (marginal) pricing but pay-as-bid: you pay or receive what you bid. In the Netherlands, BRPs can trade on the intraday market through EPEX Spot, Etpa, and NordPool Spot. The intraday market and the day-ahead market are also collectively referred to as "the spot market."[5]

Balancing markets

BRPs must balance their portfolio in advance on a quarterly basis based on forecasts of both generation and offtake. But the actual production of electricity is increasingly weather-dependent, so it always deviates slightly from the forecasts. Furthermore, the offtake of electricity per quarter-hour - mainly the offtake by small-scale consumers - cannot be predicted exactly. The electrification of part of the demand for heat and mobility further complicates this prediction. Unexpected developments can also occur, such as a power plant or factory outage. Even if a portfolio is balanced on a quarterly basis, there may be times within that quarter when the demand for electricity exceeds the production of electricity and vice versa.

When there is imbalance between production and offtake, the frequency of the power grid deviates from the 50 Hertz standard. This must be corrected, as the frequency should not deviate too much from the standard. Worst case scenario, this will lead to a nationwide power outage. TenneT - as the transmission system operator (TSO) ultimately responsible for maintaining the grid frequency of 50 Hertz - can coordinate providers of balancing services (BSPs) through various balancing markets in such a way that the balance is restored. Figure 3 summarizes the main features of the Dutch balancing markets.

[5] Source: Types of electricity markets (tennet.eu)

Frequency Containment Reserve (primary reserve)

The frequency containment reserve (FCR) balancing product was formerly referred to as "primary reserve." A contracted BSP automatically responds to the frequency of the grid. If the frequency is below 50 Hertz, the BSP starts producing more electricity (upward regulation) and if the frequency is above 50 Hertz, the BSP starts producing less electricity (downward regulation).

Potential providers of FCR power can bid one day in advance until 8 a.m. via a blind capacity auction (€/MW) for one or more four-hour time blocks. The cheapest providers will be selected. To be allowed to provide FCR, a unit must be able to provide maximum power for at least thirty consecutive minutes within the four-hour time block. The minimum required power is 1 MW (the unit must be able to provide both upward and downward capacity). It is allowed to pool several units together to reach the minimum of 1 MW.

FCR is mainly supplied by gas-fired power plants and batteries. Providers of this product only receive a fee for the contracted capacity (based on the cost of the most expensive provider selected, also called ‘marginal pricing’). Providers are not remunerated for the energy added to or withdrawn from the electricity system.

automatic Frequency Restoration Reserve (secondary reserve)

For the restoration of extensive imbalance situations, TenneT can deploy automatic Frequency Restoration Reserve (aFRR), formerly called “secondary reserve.” To ensure that sufficient aFRR capacity is available at all times, TenneT enters into bidding obligation contracts with certain BSPs. This is done through a blind capacity auction (euro per MW). At that auction, BSPs can offer capacity for the next day until 9 a.m. on the day before delivery. When the contract is awarded, they are obliged to make an energy bid (euro per MWh) no later than 2:45 p.m., for the awarded power per quarter. In other words, they must indicate the price at which they want to activate the contracted power. This bid may be changed up until thirty minutes before delivery.

Non-contracted BSPs can make so-called “free energy bids”, provided they are pre-qualified. Contracted energy bids do not have priority over free energy bids; the bid ladder is determined based on the bid price. The cheapest providers are automatically activated if necessary, via an activation signal sent by TenneT every four seconds.

Currently, gas-fired power plants primarily supply aFRR, but horticulturists (with cogeneration and/or lamps) and batteries are also increasingly playing a role. There is a plan to convert the contract period from the current 24 hours to four hours, but it is unclear when that will happen. Providers are being renumerated both for contracted capacity and energy produced or curtailed. Unlike the FCR market, the remuneration for contracted capacity on the aFRR market is pay-as-bid.

Manual Frequency Restoration Reserve (emergency power)

The balancing product manual Frequency Restoration Reserve (mFRR) used to be called "tertiary reserve.” TenneT manually activates this product in the event of incidents and long-term power anomalies. The main prerequisite for supplying mFRR is that the unit must be able to supply the matched power for the entire 24-hour contract period. This contract period - like that of the aFRR market – is planned to also go down to four hours. Mainly horticulturalists and large industrial companies are active on this market. Providers receive a renumeration for the contracted capacity (pay-as-bid) and for the energy added to or withdrawn from the electricity system.

Congestion market

Apart from the fact that electricity demand and supply in the system must be equal, the local power demand for off-take or feed-in of electricity must not exceed the local infrastructure's capacity (for an extended period). This is because it can lead to damage to the infrastructure and thus cause power outages. If, for a given area, it is expected that the maximum transmission capacity of (part of) the electricity infrastructure will be reached, congestion occurs. Congestion can be either structural or incidental. In both cases, the grid operator can ask large-scale consumers and/or CSPs to temporarily adjust their electricity transport demand. This can be done with a capacity-limiting contract (where flexible capacity is activated day-ahead) or via so-called redispatch (where flexible capacity is activated intraday).

If the market itself does not offer enough flexible capacity, grid operators can also oblige large-scale consumers with a minimum contracted capacity of 1 MW to contribute to congestion management. Large-scale consumers with a contracted capacity of more than 60 MW are obliged to offer their flexible capacity to TenneT.

Capacity limiting contract (day-ahead)

A capacity limiting contract (CBC) is a bilateral contract between a grid operator and a large-scale consumer (this can be either an end user or generator) with a contracted transmission capacity of at least 100 kW, or between a grid operator and a CSP representing one or more customers with a (joint) contracted capacity of at least 1 MW. It is a type of transmission contract in which the grid operator requests the large-scale consumer one day in advance (no later than 8:00 a.m., i.e., before the close of the day-ahead market and the FCR and FRR auctions)[6] to supply or purchase less power for a specified period of time than the maximum power normally allowed for in the contract. In exchange for limiting the power, the large-scale consumer receives financial renumeration agreed upon in the contract.[7] This type of transmission contract is relatively new and is mainly concluded with parties located in a congested area. It is intended to create additional space on the electricity grid during peak times, promoting more efficient use of the existing electricity grid.[8] Large-scale consumers with a contract up to 60 MW may independently enter into a CBC with a grid operator. Customers with larger contracts must be represented by a CSP.[9]

Redispatch (intraday)

If during the day it appears that more flexible power is needed, grid operators can use the GridOperator Platform for Congestion Solutions (GOPACS) up to fifteen minutes before delivery to issue a request for flexible power to CSPs with a contracted transmission capacity of at least 100 kW. Suppose there is feed-in congestion in a certain area at a certain time due to a lot of wind and solar power being fed in, a grid operator can send a message via GOPACS asking CSPs in that area to withdraw power from the system (either by curtailing production or by consuming more power). Then, if CSP A is willing to supply less power production in the congestion area in question (by curtailing a wind turbine, for example), a CSP outside the congestion area must do the exact opposite and thus supply more power. This is necessary to avoid imbalance of the electricity system. After all, the day-ahead market is already closed at this point, so electricity supply and demand have already been matched. The electricity that the now curtailed wind turbine would produce had already been sold. CSP A's supply obligation must therefore be taken over by CSP B, which is outside the congestion area. The grid operator then pays CSP B the difference between the price CSP A is willing to pay to curtail power production (while retaining revenue for the electricity it had already sold, but no longer has to produce) and the price CSP B is willing to receive to increase power production.

In the event of multiple bids, GOPACS chooses the cheapest bid. This bidder is then commissioned through GOPACS to deliver the flexible power. The matching of bids inside and outside the congestion area, the financial settlement, and the adjustment of the E-program all occur via an automated process.

Some CSPs enter into a bid obligation contract for redispatch. They are then obliged to bid via GOPACS to provide flexible power if a grid operator asks for it. Besides a fee per bid, some grid operators also provide a fee for entering into a bid duty contract. In return, the flexible capacity must remain available during the contract period. Bids from parties with a mandatory bid contract do not have priority over free bids in GOPACS.

Overview of timelines of different electricity markets

The figure below shows the main timelines of various electricity markets.

[6] In most cases, the contracted party may not refuse this request.

[7] In the case of generation disconnection, the less supplied amount of electricity is usually renumerated at the day-ahead price at that time. In the case of off-take, there is no standard renumeration method, in part because CBCs for off-take congestion have not yet been disconnected, if at all.

[8] There are also CBCs with a fixed time window (also called a static CBC or a rush-hour avoidance contract). This type of contract specifies at what times (time or period in the year) the large user may supply or take less power. The user usually receives no financial renumeration in return. This contract is generally not used to relieve congestion problems, but to make use of the residual capacity of the grid.

[9] Source: contracts for capturing flexible control power - Stedin, Capacity limitation contract with on-call (day ahead) - GOPACS

The energy transition has increased the need for flexibility. This means that money can be made by shifting electricity consumption and/or electricity production. This can benefit both individuals and companies that are able to strategically adapt their offtake or input of electricity. Conversely, the energy transition is a risk for parties who do not think strategically about energy. This is why it is important to have sufficient knowledge of the electricity sector and the changes that are happening in it.

The electricity sector is evolving rapidly. By 2023, half of the electricity produced was renewable. An increasing number of consumers are generating their own electricity, and electrification of transport and heating is also on the rise. All this has an impact on the load on power grids, the supply and demand balance, security of supply, and electricity prices. These developments present both risks and opportunities for electricity users. To better understand these risks and opportunities, RaboResearch is publishing a series of articles on the Dutch electricity sector. In the previous part, we explored the roles different actors play in the electricity market. This second part will discuss the different electricity markets. In the future parts, we’ll analyze the key developments impacting electricity markets, describe how these markets will develop towards 2030 and discuss the associated opportunities and risks for businesses and individuals.

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