Electricity markets explained
From using household appliances to operating industrial machinery, we’re all connected to the electricity grid day in and day out. Markets ensure that we have a safe and reliable electricity supply to meet demand.
When electricity travels from nationwide generators through to our homes and businesses, there’s lots of work happening behind the scenes to make sure supply is in balance with demand. This work is done through GB’s electricity markets.
But what exactly does that mean and why does it matter?
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.
At the ESO, we play a central role in developing electricity markets and the way they operate as GB decarbonises.
Our ambition is to see competition for the benefit of consumers. At the ESO, we’re working to remove barriers to entry and improve access to real-time electricity markets.
We’re enabling different businesses – small and large – to participate and compete, meeting the needs of consumers today while preparing for GB’s decarbonised system of tomorrow. Our Markets team is also developing new products, systems and industry codes to help us efficiently operate the system, maintain security of supply and deliver the best outcome for GB consumers.
With over 200 ESO colleagues working across Markets, we have a range of expertise as outlined below.
Our Market Services team supports the wider electricity industry, leading on the procurement and financial settlement of the balancing services we use in the Electricity National Control Centre (ENCC).
This team is responsible for the ESO’s code secretariat function, administering the Connection and Use of System Code (CUSC), Grid Code, System Operator Transmission Owner Code (STC) and Security and Quality of Standard Supply (SQSS). They also run our Charging Futures Forum.
Additionally, our Market Services team undertakes tariff setting activity and recovers network charges – including TNUoS, BSUoS, AAHEDC and Connections Charges – on behalf of industry.
The ESO’s Market Development team analyses the ongoing suitability of current GB, ESO and cross-border electricity markets in the context of operating a net zero system. With four workstreams within Market Development, this team engages stakeholders to understand the evolving energy landscape to make sure that we’re equipped to develop markets and frameworks over time.
Electricity Market Development
The Electricity Market Development workstream is responsible for developing future directions for the ESO’s balancing services markets and answering key strategic market reform questions.
This team produces our annual Markets Roadmap, where we provide a transparent view of the market reforms we are introducing. As outlined in the Roadmap, this workstream owns and applies the Market Design Objectives and Principles to the existing and future reforms of the ESO’s balancing services markets. This ensures that we’re designing markets in a robust, comprehensive and transparent way.
Additionally, this workstream is exploring potential enduring and optimal market design options to procure stability services. This work is part of our Stability Market Design innovation project.
Markets Strategy
The Market strategy workstream looks at GB’s longer term energy markets.
In particular, this group runs the ESO’s Net Zero Market Reform programme. This project was established in early 2021 to holistically examine the changes to current GB electricity market design required to achieve net zero.
Most recently, this team published their Net Zero Market Reform Phase 3 assessment and conclusions. This report explores the reasons why reform is required for GB’s electricity market design, outlining nodal pricing as a solution to reduce consumer costs on the path to net zero.
Cross-border and EU
The Cross-Border and EU workstream develops and manages the relationship with the ESO's European counterparts following the withdrawal of the UK from the EU.
It is also responsible for analysing the medium- to long-term evolution of cross-border activities as the energy system transitions to net zero both in the UK and in Europe.
The Flexibility Market Strategy team is the strategic engine thinking about the development and growth of flexibility markets that are vital in meeting our zero carbon operation ambitions. The team aims to enable and unlock flexibility, including distributed generation, storage, and demand side flexibility such as EV charging and electric heating. We engage and collaborate with a variety of stakeholders industry experts and innovators to design the roadmap to achieve that vision.
Decarbonisation, decentralisation, and digitalisation are driving significant change across the electricity network, impacting how we operate the system now and into the future. Flexibility, and especially distributed flexibility, is critical to the operation of a clean, reliable and affordable electricity system and achieving our 2035 ambition.
We believe the ESO’s markets have and will continue to play a key role in enabling flexibility in the immediate future. We have heard from industry participants that clarity in the role of different types of flexibility, clear commitments and coherency in our actions are key enablers to scale up investment and involvement in flexibility projects.
In order to grow flexibility in the mid-term from low carbon consumer and distributed resources, a Flexibility Markets Strategy is being co-created with our industry colleagues. This strategy clarifies the ESO’s vision, desired 2035 strategic objective, along with targeted outcomes for 2028. It also sets out a roadmap of actions from now to 2028 to achieve these outcomes.
Publications
ESO’s first 2028 flexibility markets strategy will be published in spring 2024.
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Our Market Change Delivery team develops a range of products and services that allow the ESO to operate a safe, secure net zero electricity system at the lowest cost to consumers. To meet these goals, they reform markets that facilitate participation from a wide range of market participants.
This team is responsible for balancing services reform. They lead response and reserve reform, including the development of new, day ahead procurement markets. They’re also developing new markets for stability and voltage services to help address emerging operability challenges.
The Market Change Delivery team delivers Pathfinder procurement events to find innovative new ways to operate the electricity system of today and tomorrow, and keep costs down for consumers.
They design and implement new systems and ways of working to make it easier to work with the ESO and participate in our markets, such as the Single Markets Platform and a new auction capability.
This team leads and delivers all of this change in partnership with industry through consultation and co-creation. The Market Change Delivery team facilitates the Power Responsive Programme to stimulate increased participation in different forms of flexible technology, such as Demand Side Response (DSR) and storage.
The ESO’s Code Change Delivery team works across GB’s technical and commercial codes, charging arrangements and cross-border frameworks. Their work enables more efficient markets and optimal consumer benefit on GB’s journey to a decarbonised electricity system.
This team works closely with the ESO’s customers and stakeholders through the open governance process for industry codes, as well as various industry work groups and governance functions.
Our Market Requirements team plays a critical role in supporting market development, design and delivery activities, working closely with the ESO’s Networks and National Control teams to support ESO ambitions to enable zero carbon system operation and competition for the benefit of consumers. The team also leads the technical design for our frequency services, enabling the delivery of our response and reserve reform commitments as part of our business plan.
They procure the ESO’s balancing services and lead on our Frequency Risk and Control Policy. Together, this work enables the identification and generation of £100s millions of consumer value each year.
The team also delivers mitigations to manage emerging system risks. This ensures that the ESO’s Electricity National Control Centre (ENCC) has the best tools to balance the supply and demand of electricity second by second in the most efficient, cost-effective way.
This involves creating models and conducting complex risk analysis with a core focus on generation supply, demands and margin; frequency risks and controls; and assessment of electricity balancing services. This results in insights to inform and support engagement with stakeholders at all levels across government, regulator and industry.
Our EMR Delivery Body team is responsible for the ESO’s Electricity Market Reform (EMR) programme of work. EMR aims to deliver low-carbon energy supplies while maintaining security of supply and minimising consumer costs. EMR includes two key mechanisms – the Capacity Market (CM) and Contracts for Difference (CfD) – that each provide incentives for the investment required for energy infrastructure.
The CM is one of the ESO’s key policies. It aims to makes sure that the future security of GB’s electricity supply comes at the lowest cost to consumers. It does this by providing regular retainer payments to reliable forms of capacity in return for such capacity being available when the system is tight.
Meanwhile, CfD is one of the key mechanisms implemented by UK government as part of EMR. It provides long-term price stabilisation to low-carbon plant, allowing investment to come forward at a lower cost of capital – and therefore a lower cost to consumers. CfD has a critical role to play in supporting our market development, design and delivery activities.
This team works closely with external customers and stakeholders through open governance process for industry codes as well as various industry work groups and governance functions.
The EMR Modelling team provides modelling expertise to government on security of supply, or how much electricity capacity – including generation, storage and interconnection with other countries – is needed to meet demand. They work to horizons that are one to five years ahead, with increasingly complex modelling reflecting GB’s transition to a net zero electricity system.
This team makes recommendations to government on how much electricity capacity to procure in the Capacity Market, which is the Government’s main policy mechanism for securing reliable electricity capacity. The Capacity Market ensures the legislated Reliability Standard of loss of load expectation (LOLE) to not exceed three hours per year.
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Did you know? Our EMR Modelling team provides recommendations for auction parameters in both one-year ahead (T-1) and four-years ahead (T-4) Capacity Market auctions. The total cost of the Capacity Market auctions that took place in February-March 2022 for delivery in 2022-23 (T-1) and 2025-26 (T-4) was £1.7 billion – showing the significance of this market. |
Additionally, this team models technology de-rating factors. These de-rating factors measure how different technologies contribute to security of supply and are used to determine Capacity Market payments to market participants. The EMR Modelling team provides annual recommendations and supporting modelling in the ESO’s annual Electricity Capacity Report. They then recommend updates to auction parameters (as required) as part of the Demand Curve Adjustment process following prequalification for the Capacity Market.
The EMR Modelling team also provides modelling expertise for the ESO’s Winter Outlook report. This report provides government and industry stakeholders insights into electricity security of supply for the winter ahead. As part of this report, the EMR Modelling team models the margins between electricity supply and demand over the winter period and forecasts whether the system will be within the Reliability Standard.
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