Electricity Market

Two approaches are used for pricing in day-ahead markets: Centralised nodal pricing and Bilateral... - P P Kulkarni,Kamal Vagrecha, Dr A P Dash

Electricity market, in India, started evolving with enactment of Electricity Act 2003, and now it is almost two decades since the transaction of electricity is going on in India under marketing mode. It has been observed that the market has generally functioned quite smoothly over these two decades. No abnormally high price spikes were seen for electricity traded through power exchanges. Also, there was near absence instances of exercise of market power by any of its constituents like generation, transmission, distribution.

During these years, the capacity addition has taken place at appreciable pace – especially in private sector, as expected under competitive marketing environment, obviously. Investment in transmission assets has also shown a similar trend. The generation technology mix has undergone desirable change with increase in share of renewable energy, a favourable outcome of appropriate policy and regulatory initiatives towards creating a market for economic, reliable in real time mode.

In the present market environment, price of electricity is being determined by market forces of demand and supply for the electricity that is being traded on exchange. Parallely sale and purchase of electricity is also taking place, under bilateral mode, at price discovered through competitive bidding route. Transaction of electricity is going on at regulated tariff for State and Central Power Generating Units.

The investment, growth and operational features of market speak good about the Indian electricity market, in terms of its design and development.

Towards bringing the electricity sector under umbrella of competitive market, the sector has been put under an Independent Regulatory Body; disintegrated into generation, transmission and distribution segments; markets for providing different services at competitive prices have been introduced; and different trading arrangements have been put in place. Seeing at the activities going on in the sector, it can be expected that discovery of prices is not a distanced phenomenon in Indian Electricity Sector.

This paper discusses about the various types of sub markets of an electricity market, their functions and price setting mechanisms for the services provided by them.

Delivered power is a bundle of many services like transmission, distribution, frequency control, voltage support, generation. Transmission & Distribution (T&D) services are responsible for delivering the power, frequency control, and voltage support services maintain the power quality, and generation services provide reliablity.

Each service requires a separate market, and some require several markets. Each service can be provided by free markets, by the state, by regulsted suppliers or by some hybrid arrangement.

The most critical service in a regulated or deregulated market is that provided by the system operator. This is coordination service. For a deregulated market, it typically includes operation of real-time markets and day-ahead market to provide scheduling and balancing services.

Exhibit 1 depicts arrangement of an electricity market pictorically.

In each of the market segment, some services have been deregulated, some are still under the umbrella of regulation. Also, even within a service, one side – either demand or supply – has been regulated while the other side has been deregulated.

For example, the supply of transmission rights is determined by the system operator, but the demand side of this market is competitive. In contrast, the demands for ancillary services are determined by the system operator while the supply sides of these markets are competitive.

Day-ahead market

Day-ahead markets are run by system operators as auctions either in the form of exchanges or pool. They are designed either as bilateral or centralised.

The bids are selected to maximise total surplus. Locational energy prices are set equal to the marginal change in total surplus when free power is injected at various locations. Each auction is specified by three sets of conditions : bidding rules, bid acceptance rules, and settlement rules. Power exchange uses one-part bids. Power pool uses multi-part bids. It has been found that a single-price day-ahead auction is efficient.

Price determination in day-ahead markets

Two approaches are used for pricing in day-ahead markets: Centralised nodal pricing & Bilateral.

The price determined by supply and demand is the highest of all the accepted supply bids or lowest price of an accepted demand bid. To determine the price, first the price is set equal to marginal surplus, which is nothing but the change in total surplus with an unit increase in costless supply.

Price setting mechanism is explained through for both unconstrained as well as constrained maekets.

In unconstrained market, the free unit of supply shifts the entire supply curve left while the amount produced and consumed remain unchanged. The result is a production cost saving of P*1kW, so the marginal surplus is P. The consumption is limited by the high cost of next available generator, but of 1kW of free supply were available, consumption would increase by 1kW. The value of consumption increases by P*1kW, and the cost of production stays constant, so total surplus increases by the same amount. In bith cases marginal surplus equals price.

In constrained market, all the suppliers are one side of the transmission constraint and all the consumers are on the other, and the free kW of supply can be introduced at either location. At the consumer end, the kW increases consumption PD. at the supplier end, the kW decreases the cost of supply, so the marginal surplus is the marginal cost of supply Ps.Because the prices are different, the system operator captures part of total surplus, but in spite of this, total surplus still equals gross marginal surplus. Setting of the market price equal to the marginal surplus is justified because it gives the competitive price and thus induces efficient behaviour. It clears the market and the trade is voluntary at these prices.

Real-time market

A real-time (RT) market primarily provides the balancing and transmission security requirements of power market. It consists of trades that are not under contract-power that shows up, or is taken, in real time and accepts the spot price. Trading takes place all the time, there is no waiting time to trade until the right price is discovered.

This centralised market can take the pool approach, exchange approach or something in between to achieve a supply-demand balance, but not the bilateral approach, which are too slow to handle real time balancing and transmission security, as traders must find partners.

RT trade takes place at RT prices and not at contract price. Thus, deviations from quantities specified in forward contracts comprise the transactions of the RT market. RT price is determines by the total actual (RT) supply & demand, whether traded under forward contracts or in RT market.

Operating reserves market

In power market there are situations when the cheap generators are required to be asked to produce less and also expensive ones to keep spinning (running) to increse reliability and moderate price spikes.

Operating reserves come in various types. Market for operating reserves has to pay the generators to behave differently from the regular energy market. Capacity-bid scoring is optimal for spinning reserves and with perfect information it is efficient.

Suppliers are asked to bid a capacity cost, energy cost and opportunity cost (for not maximising profits). Bidders with lowest capacvity bids are selected to supply spin, and from these, the ones with the lowest energy bids are selected to run when energy is needed. Accepted bids are pand the market-clearing capacity price and energy price.
Providing spin from non-spinning generators run is costly due to following reasons:

  1. Generators usually have a minimum generation limit below which they cannot operate and remain stable.
    2. Generators have to incur no-load costs on start up and shut down, as these are unrelated to their output.

Providing spin from inframarginal generators, ones with marginal costs below the market price, is also expensive. If a cheap generator has been backed down slightly from full output and other generator has been asked to provide the backdown quantity, due to reason like too little spin available from a marginal or extra-marginal generator, the cost of providing spin will go up.

It is because marginal cost of operating generator may be less than the competitive price as compared to the one which has been asked to spin. This is typically the case when the market price is above the variable cost of most generating capacity.

Ancillary services market

Power is the primary service but six ancillary services are needed to ensure reliable, high-quality power, efficiently produced. Of the six ancillary services system operator directly provides transmission security and trade enforcement and to some extent economic dispatch. The other services, balancing, voltage stability, and black-start capability can be purchased from competitive market.

The system operator keeps the system in balance by keeping the supply equal to demand (consumption). As many as five markets are required to accomplish this : one for ‘regulation’ which works minute to minute and other four to handle larger deviations and emergencies.

Ancillary services benefit the entire market and are either public goods or have large external effects. Consequently, all the markets have a fully regulated demand side, but some can be regulated on supply side. The system operator service, which coordinates these markets and provides the regulated demand for ancillary services, is a natural monopoly service and can be provided for by a nonprofit or for-profit entity.

To supply balancing services the system operator can purchase the necessary services in a market and assign the cost to either loads or generators on pro rata basis, or it can assign each supplier a fraction of the physical requirement. The later approach is called ‘self-providing’ and is less regulated one.

Frequency stability cannot be provided by individual system operator, but each is required to balance the real power flow in its control area taking into account a frequency correction. When every system provides this balancing service, they collectively provide frequency stability.

Voltage support is provided passively by capacitor banks and actively by generators. Provision is by the supply of ‘reactive’ power which is difficult to transmit. This makes it difficult to purchase under competitive conditions, but long-term contracts that permit competition through entry should be helpful.

Transmission security can be provided initially through the control of transmission rights or operation of day-ahead energy markets with locational prices. In real time, a locational balancing market is be used.

Economic dispatch refers to using the right generators in the right amounts at right times in order to minimise the total cost of production. This service is provided by scheduling and dispatch services.

Three basic approaches are used to keep the system balance. Small random fluctuations are handled by ‘regulation,’ which utilises generators that receive a control signal directly from the system. Predictable daily fluctuations like ‘morning ramp’ are handled by scheduling generation and in unregulated system, by the balancing market. Unexpected generation and transmission outages are handled by operating reserves of various types starting with 10-minute spinning reserves.

Regulation and operating reserves are generally purchased by the system operator in the market. Tracking the more predictable and larger-scale fluctuations in demand can best be handled by a DA market, on hour-ahead basis and an RT market.

The system operator can purchase long-term contracts for the provision of reactive power. Transmission security service is provided by the system operator by selling transmission rights or by controlling the acceptance of energy bids in a DA auction. For economic dispatch 3 basis approaches are used.

  1. Bilateral trading
    2. A centralised DA power exchange
    3. A centralised DA poer pool

Under the bilateral trading arrangement suppliers and power traders ensure economic dispatch. Under the centralised DA power exchange appraoch the system operator helps by running a DA exchange.

The exchange provides a public price which is either used by the exchange to select the generators that should start up or could be used by suppliers to self-select during several rounds of bidding.

In the centralised power pool approach power pool would require generators to submit bids and the system operator would optimize the dispatch using all available bid information. That optimisation would be used to control the actual dispatch through prices and start-up insurance.

Transmission rights market

The impact of transmission-price risk on the market are reduced by making use of financial transmission rights and physical transmission rights. The financial transmission right pays to transmission line owner the RT cost of transmission on a given path, while the physical transmission right gives its owner the right to use the path. Both types of rights make good hedges.

If a 200 MW trade from P to Q is accompained by a matching financial right, it can proceed with confidence that its transmission costs will be paid in full. All risk is eliminated. If the same trade is accompained by matching physical right, the trade is permitted to execute without charge.


For providing power to consumers at competitive prices through a transparent and reliable mechanism, various steps have been taken right from unbundling of vettically integrated utlitties to creation of markets for providing various services through healthy competition. These markets provide services through three main trading arrangements viz bilateral, pool, exchange. It is expected that these arrangements would ultimately lead towards discovery of price as well as clearing of the market through healthy competition.

If you want to share thoughts or feedback on this article, please leave a comment below.