Introduction to Energy Markets
Why energy markets exist
Electricity has a unique economic property:
- It is an essential good for society and industry.
- It cannot be cheaply stored at scale.
- Supply must match demand in real time, every second of every day. This constraint makes electricity fundamentally different from other commodities and is the reason organised markets exist to coordinate production and consumption.
Before liberalisation, vertically integrated utilities handled generation, transmission, and retail under a single entity. Market reforms across Europe, beginning in the 1990s, unbundled these functions to introduce competition, improve efficiency, and reduce costs for consumers. European spot power markets are coupled, to provide electricity across border when and where it is needed.
Types of energy traded
European energy markets facilitate trade in several product categories:
- Electricity: The primary focus of this course. Traded in day-ahead, intraday, and forward/futures markets.
- Natural gas: A significant input fuel for gas-fired power plants and a major traded commodity in its own right.
- Carbon emissions (EU ETS): Emission allowances that affect the marginal cost of fossil-fuel generation.
- Renewable certificates: Guarantees of origin and similar instruments tracking renewable generation.
Each of these products interacts with the others. Gas prices influence electricity prices through the merit order. Carbon prices add a cost layer to thermal generation. Understanding these linkages is essential for anyone modelling energy markets.
Physical vs. financial products
Energy products can be broadly classified as:
Physical delivery
Physical contracts result in the actual delivery (or offtake) of electricity at a specific grid connection point. Day-ahead and intraday markets are predominantly physical markets — a buyer is committing to receive energy, and a seller is committing to produce or deliver it.
Financial settlement
Financial contracts (futures, options, swaps) reference an energy price index but settle in cash. They are used for hedging and speculation. A generator might sell forward contracts to lock in revenue; a retailer might buy them to stabilise procurement costs.
The distinction matters because physical markets are subject to grid constraints and balancing obligations, while financial markets are governed by different regulatory frameworks (e.g., REMIT, MiFID II).
The European landscape
The European electricity market is not a single market but a network of coupled national and regional markets. Key institutions include:
- ENTSO-E: The association of European transmission system operators, responsible for coordinating cross-border flows and system adequacy.
- ACER: The EU Agency for the Cooperation of Energy Regulators, overseeing wholesale market integrity.
- Power exchanges: EPEX SPOT (Central Western Europe), Nord Pool (Nordic and Baltic), OMIE (Iberian Peninsula), and others operate the day-ahead and intraday auction platforms.
Market coupling — the process of linking national day-ahead auctions through a common algorithm (EUPHEMIA) — ensures that electricity flows from lower-price to higher-price zones up to the limit of cross-border transmission capacity.
Summary
Energy markets exist because electricity cannot be stored economically, so real-time coordination between supply and demand is essential. European markets trade electricity, gas, carbon, and related products across physical and financial dimensions. The institutional framework connects national markets through coupling algorithms and shared regulatory oversight.
In the next module, we examine how these markets are structured in practice: the day-ahead auction, intraday continuous trading, and balancing mechanisms.