U.S. Energy Markets 101: How Electricity Markets Work

The structure of the U.S. electricity market is complicated, to say the least. It reflects years of debates over federal vs. states' rights, market regulation vs. deregulation, monopolies vs. competition, and who should be responsible for the generation, transmission, and distribution of power. In this primer, we will explore how energy markets work, the importance of competition in the energy markets, and how that affects the options that corporations have when buying renewable energy.

Let's start from the beginning...

Vertically-Integrated Energy Markets

After inventing the lightbulb in 1879, Thomas Edison opened the United States' first electrical power plant in lower Manhattan. The coal-fired Pearl Street Station was only 50 by 100 ft and served less than 100 customers (including J.P. Morgan, himself). Because there was no existing infrastructure for the delivery of electricity, in order to deliver the power from Pearl Street, it was incumbent on Edison to build, own, and operate the first electrical distribution systems, as well. This "vertically-integrated" model of electricity distribution, where a single company owns the power plants, transmission lines, distribution lines, and delivers electricity directly to the end customer, served as the model for most electric utility companies that followed. In fact, Edison's utility, the Edison Illuminating Company, is still around today as Consolidated Edison (Con Ed), one of the biggest power suppliers in the country.

Though small, the Pearl Street Station marked a tremendous achievement for the burgeoning electricity market and sparked fierce competition between wealthy investors to dominate it. Within two years of its opening, dozens of new utilities had emerged across the country mimicking the Pearl Street business model. But as Manhattan became blanketed with thousands of power lines, serious safety and reliability concerns came to the fore.

To put it into perspective, imagine a city block where two neighbors bought electricity from two different utility companies, Utility A and B. Each customer would then have entirely different transmission lines and power plants delivering power to them. So, when the power plants of Utility A stopped working, all of its customers would lose power, while all of Utility B's customers still had their lights on. Of course, the first power plants and transmission lines didn't always work how they were supposed to (Pearl Street caught on fire within the first two years of operation), so blackouts--and upset customers--were very common.

To address this issue, savvy businessmen lobbied the local and state governments to allow for the consolidation of monopolies. They successfully argued that publicly-regulated monopolies could keep prices lower and make the grid more reliable and safe. Thus, competition was eliminated and single utility companies were given the power to own and operate all transmission within a given geographic region.

Today, this is the hallmark of vertically-integrated energy markets. Also known as known as "traditionally regulated" markets, vertically-integrated regions still exist in many parts of the country. In these markets, utility companies, 80% of which are still privately-owned, own the transmission and distribution lines and all associated infrastructure, including the power supply itself.

The Emergence of the U.S. Electricity Grid

From New York and elsewhere in the United States, the electricity grids grew to encompass the entire nation. Despite many references to "the grid" in pop culture, America doesn't have a single power grid. There are actually three grids that serve the lower 48 states, which are known as "interconnections": The Western Interconnect, Eastern Interconnect and Texas Interconnect (also known as the Electric Reliability Council of Texas, or ERCOT). These interconnections operate relatively independently, meaning very little power is shared between them. Within these interconnections, there are vertically-integrated energy markets and competitive wholesale electricity markets.

Wholesale Electricity Markets

As Americans began relying more and more on electricity, there were increasing numbers of blackouts across the country and confidence in the monopolistic, private utilities dropped sharply. It was determined that more oversight was needed on a federal level - Enter the Federal Energy Regulatory Commission (FERC). Founded in 1977, FERC set out to regulate the transmission and wholesale sale of energy and transport across state and federal borders. (Fun fact: Because the Texas Interconnect does not cross state boundaries, it is not subject to FERC oversight.) Regarding the electricity grid, FERC is responsible for ensuring policies are in place that prevent major power outages.

To stymie FERC's intervention, in the 1990s, power generators, utilities, and transmission owners came together to form organizations called, Independent System Operators (ISOs). These private, non-profit organizations received FERC approval to self-regulate and share transmission responsibilities. The ISOs are charged with overseeing the commodity market for electricity in their respective jurisdictions by dispatching power generation, controlling transmission and distribution, and guarantying sufficient generating capability to meet demand (i.e. to ensure reliability!).

There are seven Regional Transmission Organizations (RTO)/Independent System Operators (ISOs) in the U.S.:

1.   California Independent Service Operator (CAISO)
2.   Midcontinent Independent System Operator (MISO)
3.   New York Independent Service Operator (NYISO)
4.   Independent Service Operator New England (ISO-NE)
5.   PJM Interconnection (PJM)
6.   Southwest Power Pool (SPP)
7.   Electric Reliability Council of Texas (ERCOT)

And two RTO/ISOs in Canada:

1.  Alberta Electric System Operator (AESO)
2.  Independent Electric System Operator (IESO)

Relevant to corporate buyers of renewable energy, ISOs play a key role in managing a competitive market for energy supply. In a wholesale electricity market, the price for electricity is changing every five minutes according to factors like demand and, increasingly, wind and solar resources.

The competitive wholesale market enabled the eventual development of the corporate virtual power purchase agreement (VPPA), by providing a liquid reference price against which the VPPA settles financially. See our blog post, "Introduction to Virtual Power Purchase Agreements" for more details on how this contract works.

While over two-thirds of the country are within an ISO, some utilities and states still operate under the traditional, vertically-integrated model - if the ISOs are 'free markets,' these traditional utility models are monopolies - located in parts of the West and most of the Southeast. These monopolistic traditional utility models do not provide opportunities for corporates to enter into VPPAs for renewable energy.

What is retail electricity choice?

To further complicate the electricity landscape, within both vertically-integrated and wholesale markets, states can have either regulated or deregulated (i.e., competitive) retail electricity markets.

In regulated retail markets (not to be confused with the "traditionally regulated"/vertically-integrated markets), there is not competition between utilities for end consumers. In other words, the incumbent utility monopoly is the only available supplier of electricity. Residential and commercial users in regulated retail markets cannot shop for a different electricity supplier the same way they would for, say, a TV/Internet provider. In such markets, which are defined at the state-level, end electricity consumers do not have "retail choice." Instead, utilities are regulated by Public Utility Commissions (PUCs) to ensure monopolies do not inflate prices unfairly for the public.

On the other hand, in deregulated retail markets, retail electricity providers compete to sell electricity to the end consumer. In these markets, the incumbent utilities still own the distribution (and sometimes the transmission) wires, and simply charge the competitive electricity suppliers for access. There are 18 states in the U.S. that offer retail electricity choice, allowing residential and commercial users to choose their electricity provider. Advocates for deregulation argue that introducing competition to the market keeps prices low for consumers and encourages more innovation in grid operations.

Competitive Renewable Energy Supply

Decades of competition and innovation have transformed the landscape of energy markets around the globe. Now, LevelTen Energy is leading the rapid growth of clean energy growth in the United States, Canada, and Europe by building competitive marketplaces for renewable energy supply. Unparalleled in the industry, the LevelTen Energy Marketplace is serving hundreds of buyers and sellers of renewable energy to transact on competitive supply offers, enabled by real-time analytics, incentives for developers to post their most up-to-date prices, and market transparency that is unavailable anywhere else. Already, new structures and aggregations are being developed, and there is no limit to where it will take us.

If your company is thinking about procuring renewable energy to meet its sustainability goals, LevelTen Energy advisors can help you understand your options. Contact us to learn more.