Electricity markets explained

Before delving into all things electricity, let’s begin with the basics.

In an economic sense, markets enable the exchange of goods or services. They involve transactions between buyers and sellers, either directly or through mediating institutions.

Markets can be literal, like a chain grocery store or local farmers’ market, where buyers can purchase commodities from vendors. In wider systems, however, markets can span beyond physical places. The real estate market and electricity market, for example, include wide geographical areas in which sellers compete.

From industrial machinery to household kettles, electricity demand comes from a wide range of consumer activity. In the electricity market, demand refers to the combined power required by all consumers – both domestic and industrial – at any given time.

Meanwhile, supply comes from electricity generators – including solar, wind, nuclear and other plant types. Generators are responsible for increasing or decreasing the amount of electricity available to meet consumer demand.

The ESO’s role is to balance supply and demand. At the ESO, the Electricity National Control Centre (ENCC) closely monitors demand on a second-by-second basis. We then forecast how much electricity is needed at any given time. Generators use our forecasts to plan how much electricity they can provide, as well as how much it will cost to do so.

There are several different markets operating across GB’s electricity system, some of the key ones being:

• Wholesale electricity markets include the sale and purchase of electricity between suppliers and generators.
• Retail electricity markets involve suppliers selling electricity direct to consumers.
• The balancing mechanism market refers to how the ESO balances real-time supply and demand through the Balancing Mechanism.
• Balancing services market include the range of services across the ESO that ensure the security and quality of electricity supply across GB’s transmission system.

There are four main parties in the electricity market, which each play different roles depending on the type of electricity market in question:

• Generators – from renewable resources to fossil fuels, embedded generation to transmission-connected generation – use different fuel sources and technologies to generate electricity.
• Consumers aren’t limited to families turning on appliances in their homes. In the electricity market, consumers also include factories, hospitals, transport and other services that use electricity.
• Suppliers meet generators and consumers in the middle. These companies buy electricity from generators, which they then sell to customers.
• Flexibility providers ensure energy system flexibility, which is the ability to adjust supply and demand to achieve energy balance. enable the

Learn more about the roles within GB’s electricity landscape, including how the ESO fits into the bigger picture.  

The wholesale electricity market is where electricity is bought and sold before being delivered to consumers. Its two main participants are generators and suppliers.

In GB, suppliers purchase electricity from generators at a wholesale price, which reflects the cost of electricity generation to meet consumer demand at any given time.

In the wholesale market, there are three main models that determine how wholesale electricity is priced. In Great Britain, we currently use a system called national pricing. This means that at any given moment, there’s one price for wholesale electricity across the country.

The wholesale price of electricity depends on a range of factors, including the level of demand, carbon taxes, cost of fuel and availability of resources like wind and sun. This price therefore fluctuates throughout the day, which can affect which generators are most competitive in the wholesale market.

This market involves the selling of electricity from suppliers to their customers. Its main participants are therefore suppliers and consumers.

This retail electricity market is the one that’s most familiar to everyday consumers. When we pay our electricity bills or chose which company supplies power to our homes, workplaces and communities, we’re interacting with the retail electricity market.

Retail market interactions take place after suppliers procure electricity from generators in the wholesale electricity market. Once they’ve bought electricity to meet the demand of their customers, suppliers provide this electricity to their contracted customers across GB.

The balancing mechanism market centres the ESO’s primary tool for balancing GB’s electricity supply and demand in real time – the Balancing Mechanism (BM). This market primarily involves generator and supplier participants and is orchestrated through the ESO.

Generators enter the balancing mechanism electricity market by submitting “bid” or “offer” data into the BM, which describes the amount of electricity they can offer at their best price. An offer is a proposal to reduce demand or increase generation, while a bid is a proposal to increase demand or reduce generation. They then compete with other participants to provide electricity.

The ESO receives BM bid and offer data from generators 24/7, split into half-hour windows called settlement periods. Using our forecasted demand, the ESO reviews these submissions and takes the lowest price offered until demand is met. This system of low-cost preference is called merit order. Merit order determines which generation sources will be brought onto the system, starting with the options that can generate the most electricity for the lowest price. Moving down this list, we instruct generators to come online.

Merit order can vary in the short term, with preferred generators changing each hour. It also follows a seasonal pattern, with consumer behaviour (like use of heat) and resource availability (like the amount of sunlight needed to generate solar power) fluctuating throughout the year.

With so many factors dictating price and availability in the balancing mechanism market, it’s essential that the ESO facilitates and evaluates market participation in real time. This makes sure that we can maintain a reliable supply of electricity while operating the grid in the most efficient, cost-effective way for consumers.

Along with the BM, we also procure a wide range of services to balance supply and demand while ensuring the security and quality of electricity supply across GB’s transmission system. These balancing services ensure that GB’s system remains stable, safe and efficient.

The ESO designs, delivers and operates balancing services markets to meet system needs and minimise costs to consumers. Across the ESO, we operate several balancing services markets, including:

• Frequency Response: We have a licence obligation to control system frequency at 50Hz, plus or minus 1%. We buy frequency response services to make sure there is sufficient generation and demand held in readiness to manage all credible circumstances that might result in frequency variations. Frequency response services include Dynamic Containment, Dynamic Moderation and Dynamic Regulation as well as mandatory response services.
• Reserve: Reserve services are the additional power sources available to the ESO. They enable us to manage peaks in electricity demand through increased generation or demand reduction. The ESO operates several unique balancing services to meet different reserve requirements on the system. For example, our fast reserve service provides rapid, reliable active power delivery at the time that reserve services are quickly needed, while short-term operating reserve (STOR) works ahead of time to procure sources of extra power.
• Reactive Power: Reactive power services are how we make sure voltage levels on the system remain within a given range, above or below nominal voltage levels. We instruct generators or other asset owners to either absorb or generate reactive power.
• System Restoration: Restoration (formerly known as Black Start) is the process used to restore power in the event of a total or partial shutdown of the national electricity transmission system.

Historically, GB sourced its electricity supply from large coal and gas power stations. But as we’ve transitioned to a more diversified electricity mix to meet decarbonisation goals, the grid has become more complex than ever before.

Markets are key to ensure safe and reliable electricity supply at an efficient cost to consumers – meaning that markets will play a critical role on the road to net zero. Markets need to take us from where we are today to a future energy system that looks very different across supply, demand and networks.

Markets are the revenue streams for electricity system contributors. Their design is therefore critical in enabling the required capacity mix, cost and security of supply needed to achieve net zero.