The key to unlocking the climate capital stack
Longtime transmission guru Carl Zichella once called the American electric grid the “most complicated machine we’ve ever built”, and with $1T of IRA-driven renewable investments in the pipeline, it’s only going to get more complex. The power grid, in the US or in markets around the globe, is an intricate web of transmission and distribution lines, regulated operators, and markets.
The promise of a clean energy future predicated on abundant, cheap, green electrons starts with the grid. But while the grid serves as the underlying infrastructure, the power markets keep the entire operation humming and direct the complex flow of electrons from generators to consumers.
Next week, we’ll deep-dive into the nuts and bolts of the technologies that make our grid more reliable, resilient, and clean (aka ‘gridtech’). But first, we’ll set the stage for how the power markets work, who the players are, and how the grid of the future is starting to take shape.
The power markets have evolved significantly since Edison’s Pearl Street in 1882. Regulated markets where vertically integrated utilities control the full power generation, transmission, and distribution value chain have been opening up into more competitive wholesale power markets. Here, electricity can be traded between generators and retailers before being sold to consumers (for a longer history, check out the aptly-named The Grid).
Power market deregulation set the stage for the grid we know today, which is why we’ll be focusing exclusively on the wholesale power market in this feature.
Wholesale power markets serve two primary functions:
1. Act as a matchmaker between electricity buyers and sellers. In doing so, the market must ensure electricity delivery is reliable, resilient, and at the best possible price for consumers. And where required and/or possible, clean. Utility priorities run roughly in the following order: Safety first, reliability second, price third, and finally clean.
2. Inform participants, through price signals, on decisions to improve market system design. This generally includes introducing incentives or regulations to drive grid reliability and operations or alleviate congestion.
There are three core players in wholesale power markets - generators, operators, and utilities. However, increased grid flexibility has enabled other players to participate, providing ancillary services.
Power markets broadly break down into day-ahead and real-time categories:
Both markets act through an auction process and follow a merit order structure, where generator bids are sorted by price. The auction process works as follows:
Of course it’s more complex, but the power market stack can be summarized into four main components: the electricity itself, transmission, capacity, and ancillary services.
Electricity is of course the shining star of the show, which is also why power markets differ from conventional markets. Unlike financial, retail, or other commodity markets, it’s not just about the pricing mechanism involved, but the underlying electrons that flow from generators to consumers. So on top of balancing demand/supply in the abstract or financial sense, managing the electricity itself is crucial.
Grids come in all shapes and sizes. In the UK, there is one main grid covering England, Scotland, and Wales. In other locations, grids stretch across international borders. In the continental US, there are three power grids. The Eastern and Western Interconnects, divided by the Rocky mountains, and the Texas Interconnect which is located, you guessed it, in Texas.
In each of these grids every solar module, natural gas, and nuclear power plant is synchronized to generate energy at exactly 60 Hz. This harmonious design keeps a potentially dissonant cacophony of electricity humming along smoothly for millions of consumers at every moment. If things go out of tune, either runaway electrons or scant supply can melt the system, resulting in widespread blackouts.
For much of the US, the Independent System Operators (ISOs) and Regional Transmission Organizations (RTOs) are the conductors of this electric light orchestra and balance supply and demand. They represent about two thirds of the US grid, with the rest operated by vertically integrated utilities.
To ensure supply perfectly matches demand at all times, grid operators perform three primary duties.
Each of these three competencies intertwine and exist for two main reasons: grid reliability and value creation. New transmission investment today has a direct effect on how grid operators manage future energy flows. Understanding energy industry decisions often requires following the money or the electrons, both of which rest at the center of wholesale energy markets.
Capacity markets exist to guarantee that generation supply will meet projected electricity demand. Grid operators pay power generators to be available at a specified time, whether they’re needed or not. These agreements incentivize generators to maintain existing resources and finance new ones, to increase grid capacity.
But not all megawatts are created equal. Every generator type is compensated differently for the MW they contribute to the system in a process called capacity accreditation. This accreditation is dependent on a generator's ability to contribute to supply during times of peak load.
There are several up-and-coming technologies directly affected by capacity market design:
Ancillary services are the stabilizers of the power markets and incentivize new generators to keep the system ticking during emergency situations. They are the metronomes of the grid, pulling the players back in sync when they veer off course, through a few key functions.
All these functions help to maintain grid reliability and health, and provide a healthy revenue stream. Electric Power Research Institute (EPRI) estimated that the total value of ancillary services in the United States was around $10B in 2020. Innovators have been taking note and are looking to reap the rewards.
The key to unlocking the climate capital stack
(Bonus edition) Part III: The software “middleware” layer for grid operators / utilities
Part II: How grid tech is the rails of the energy transition