Shift Key Summer School: How Do Power Markets Work?

Most electricity used in America today is sold on a wholesale power market. These markets are one of the most important institutions structuring the modern U.S. energy economy, but they’re also not very well understood, even in climate nerd circles. And after all: How would you even run a market for something that’s used at the second it’s created — and moves at the speed of light?

On this week’s episode of Shift Key Summer School, Rob and Jesse talk about how electricity finds a price and how modern power markets work. Why run a power market in the first place? Who makes the most money in power markets? How do you encourage new power plants to get built? And what do power markets mean for renewables?

Shift Key is hosted by Jesse Jenkins, a professor of energy systems engineering at Princeton University, and Robinson Meyer, Heatmap’s executive editor.

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Here is an excerpt from our conversation:

Jesse Jenkins: If I’m just a utility operating on my own, I want to basically run my fleet on what we call economic dispatch, which is rank ordering them from cheapest to most expensive on a fuel or variable cost basis, and trying to maximize my use of the less expensive generators and only turn on the more expensive generators when I need them.

That introduces this idea of a marginal generator, where the marginal generator is the last one I turned on that has some slack to move up or down as demand changes. And what that means is that if I have one more megawatt-hour of demand in that hour — or over a five-minute period, or whatever — or 1 megawatt-hour less, then I’m going to crank that one generator up or down. And so the marginal cost of that megawatt-hour of demand is the variable cost of that marginal generator. So if it’s a gas plant that can turn up or down, say it’s $40 a megawatt-hour to pay for its fuel, the cost on the margin of me turning on my lights and consuming a little bit more is that that one power plant is going to ramp its power up a little bit, or down if I turn something off.

And so the way we identify what the marginal value of supplying a little bit more electricity or consuming a little bit more electricity is the variable cost of that last generator, not the average cost of all the generators that are operating, because that’s the one that would change if I were to increase or decrease my output.

Does that make any sense?

Robinson Meyer: It does. In other words, the marginal cost for the whole system is a property of the power plant on the margin, which I realize is tautological. But basically, the marginal cost for increasing output for the entire system by 1 megawatt-hour is actually a property of the one plant that you would turn on to produce that megawatt-hour.

Jesse Jenkins: That’s right, exactly. And that can change over the course of the day. So if demand’s really high, that might be my gas plant that’s on the margin. But if demand is low, or in the middle of the day, that gas plant might be off, and the marginal generator during those periods might be the coal plant or even the nuclear plant at the bottom of the supply curve.

Mentioned:

Jesse’s slides on electricity pricing in the short run

Jesse’s lecture slides on electricity pricing in the long run

“The duck curve”

Shift Key Summer School episodes 1, 2, and 3

This episode of Shift Key is sponsored by …

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Music for Shift Key is by Adam Kromelow.