Various factors influence the price of electricity at any given location at any point in time. Generally speaking, market-based prices are determined by market perceptions of the supply/demand balance. Wholesale electricity prices are usually determined in one of two ways — through bilateral transactions or through centralized auctions.
Until the advent of ISOs, bilateral trading encompassed virtually all market-based wholesale transactions, and this is still the predominant method for all pricing negotiated further ahead than the next day. Centralized auctions are run by ISOs or Power Exchanges (PXs) for day-ahead and real-time energy markets, and in some regions for forward capacity or energy markets.
Prices in bilateral transactions are driven by each organization’s perception of supply and demand and what each party considers a fair price. Centralized auctions use marginal pricing that is determined by the price offer that would be accepted if the market required one more MW than the amount of supply required.
Pricing in centralized auctions can be highly volatile based on hourly variations in supply and demand. Offer by supply providers may be greater than just the variable cost of operation. At some point in the year, owners of generation need to recover not only variable costs but also fixed costs, debt costs, and a margin of profit. Any such costs not received in capacity payments must be captured in energy markets. Other factors that impact prices are the availability of renewable energy on the system, the availability of power imported from other regions, and price-response demand response customers participating in the market. In the future, market participation by storage may also impact prices.
Centralized auctions commonly set different prices for the same time period:
Day-ahead price: An hourly price that is determined during a co-optimized day-ahead auction
Fifteen-minute real-time price: A price determined during the operating hour for units willing to ramp up or down for a fifteen-minute period
Five-minute real-time price: A price determined during the operating hour for units willing to ramp up or down for a five-minute period.
Many ISOs use a pricing methodology called Locational Marginal Pricing (LMP). In this case prices not only vary by time but are different in different locations due to line losses and transmission congestion.