How do you price energy in a power system?

1 Demand and supply

The most basic factor that affects energy prices is the interaction between demand and supply. Demand is the amount of electricity that consumers want to use at any given time, and supply is the amount of electricity that generators can produce and deliver to the grid. Demand and supply vary throughout the day, week, season, and year, depending on factors such as weather, time of day, economic activity, and consumer behavior. When demand exceeds supply, prices rise to encourage more generation or less consumption. When supply exceeds demand, prices fall to discourage excess generation or encourage more consumption.

2 Reliability and security

Another factor that influences energy prices is the need to ensure reliability and security of the power system. Reliability means that the power system can meet the demand at all times, even in the face of uncertainties and contingencies. Security means that the power system can withstand disturbances and maintain stability and quality of service. To achieve reliability and security, the power system needs adequate capacity, reserves, flexibility, and coordination among different actors. These aspects have a cost that is reflected in the energy prices, either directly or indirectly.

3 Costs and benefits

A third factor that affects energy prices is the recognition of the costs and benefits of different resources. Resources are the sources of electricity generation, such as coal, gas, nuclear, hydro, wind, solar, etc. Each resource has different characteristics, such as capital cost, operating cost, environmental impact, availability, variability, etc. These characteristics determine the value and competitiveness of each resource in the power system. Energy prices should reflect the true costs and benefits of each resource, taking into account not only the direct costs of production, but also the externalities, such as emissions, health, and social impacts.

4 Energy markets and pricing mechanisms

To determine the energy prices in a power system, there are different types of energy markets and pricing mechanisms. Energy markets are platforms where buyers and sellers of electricity interact and exchange energy and related services. Pricing mechanisms are the rules and methods that define how the energy prices are calculated and settled. Depending on the degree of competition, regulation, and integration, various models of energy markets and pricing mechanisms exist. For instance, wholesale markets enable large-scale generators and consumers to trade energy in bulk for short-term delivery, while retail markets facilitate small-scale consumers and producers to trade energy directly or through intermediaries. Additionally, ancillary services markets allow for specific services that support the reliability and security of the power system to be traded; these can be mandatory or voluntary depending on the system operator's requirements. Spot markets enable energy to be traded for immediate or near-term delivery, while forward markets facilitate trading for future delivery; furthermore, energy-only markets determine prices based on supply and demand, while capacity markets add payments for availability of capacity. Retail markets can be regulated or deregulated, depending on whether energy prices are set by authorities or utilities or determined by market forces or contracts; additionally, they can also be dynamic or static, depending on whether prices vary according to wholesale market conditions or signals or are fixed.