Electricity is bought, sold and traded in wholesale energy markets in order to meet demand, preserve reliability and hedge or mitigate risk. These markets operate similarly to wholesale and retail markets for other commodities. The purchase and sale of electricity to resellers (entities that purchase goods or services with the intention to resell them to another party) is done in the wholesale market. Electricity that is sold to consumers by utilities is considered a retail transaction.
Organized wholesale electricity markets were created to address increasing electricity prices and to encourage innovation through open competition. Competition has helped to create a less expensive and more reliable grid that can offer market-based options and solutions for public policymakers and industry alike.
The wholesale market refers to the buying and selling of power between the generators and resellers. In some markets, resellers include electricity utility companies, competitive power providers and electricity marketers. For most regions within the United States, the operation of and transactions in the wholesale market are regulated by the Federal Energy Regulatory Commission- FERC.
The wholesale market begins with generators, which, after securing the necessary approval, connect to the grid and generate electricity. The electricity produced by generators is bought by an entity that will often, in turn, resell that power to meet end-user demand. These resale entities will generally buy electricity through markets or through contracts between individual buyers or sellers. In most cases, utilities own their own generation and sell directly to end-use customers. The price for wholesale electricity can be predetermined by a buyer and seller through a bilateral contract (a contract in which a mutual agreement has been made between parties) or it can be set by and in wholesale markets. The clearing price for electricity in these wholesale markets is determined by an auction in which generation resources offer in a price at which they can supply a specific number of megawatt-hours of power. If a resource submits a successful bid and will therefore be contributing its generation to meet demand, it is said to “clear” the market. Resources are stacked up, like blocks wherein the least expensive resource “clear” the market first, followed by the next cheapest option until demand is met. When supply matches demand, the market is “cleared,” and the price of the last resource to offer in (known as the marginal unit), sets the wholesale price of power.