Why Electricity Is Different
The instantaneous balance constraint, frequency as the signal that balance is holding, and why power cannot leave the grid it was born on.
Words the industry uses are marked like this at the sentence that defines them, so you can tell a term you will hear on a desk from a phrase this book happens to be using.
Just after two in the afternoon on an unremarkable Tuesday, somewhere in a control room with too many screens, an operator watches a number that almost never moves. In North America it reads 60.00. In most of the rest of the world it reads 50.00.
The number is frequency. Electricity reaches a wall socket as alternating current, which means the flow of electrical charge reverses direction over and over rather than running steadily one way, and 60.00 means it completes sixty full reversals every second. What matters is where the number comes from. It is set by the physical rotation speed of the generators, which are large magnets being spun inside coils of wire, all turning in step with one another. Frequency is a speedometer reading for every big machine on the system at once.
The system those machines belong to is the grid: the network of wires, transformers and switching stations that connects every generator to every customer across a region, often across several countries. Chapter 3 covers what it is made of. The only property needed here is that everything electrically joined to a grid experiences the same frequency at the same instant, so that one number describes the health of the whole thing.
If more power is being consumed than generated, the number falls. If more is being generated than consumed, it rises. Not eventually. Now. There is no warehouse between the two sides of the trade, no tank farm, no floating storage, no inventory of any kind sitting between the generator and the kettle. Supply and demand are the same quantity on this system, continuously, or it comes apart.
Every other market in this series has a buffer. Oil has tankage at every stage from the lease to the refinery to the terminal, and when the market ran out of onshore space in 2020 it went to sea. Nat gas has salt caverns and depleted reservoirs and the whole seasonal rhythm of injection and withdrawal. Those buffers are what let a price be wrong for a while without anything breaking. Electricity has no such forgiveness, and almost every strange feature of a power market traces back to that one fact.
How big is a megawatt
Everything after this is counted in watts and multiples of them, so here is the scale. A watt is a rate rather than a quantity. It measures how fast energy is moving at this instant, the way a speed measures how fast a car is moving. A watt-hour is the quantity that rate delivers over time, the way a distance is what a speed delivers over time. For a reader arriving from oil the translation is exact: a megawatt is barrels per day, and a megawatt-hour is barrels.
Table 1-1: The ladder, and something to hold on to at each rung
| Unit | Equals | What that is |
|---|---|---|
| Watt (W) | The base unit | A resting human body gives off about 100 watts of heat. An LED bulb bright enough to read by draws about 8. |
| Kilowatt (kW) | 1,000 W | A kettle, one to three kilowatts depending on which side of the Atlantic it is plugged into. An American house averages a little over one kilowatt across the year. |
| Megawatt (MW) | 1,000 kW | One large offshore wind turbine, about 15 MW. A megawatt running continuously for a year covers roughly 800 American homes. |
| Gigawatt (GW) | 1,000 MW | One big nuclear reactor. A year of it covers all the electricity used by about 700,000 Americans, or about 1.5 million Europeans, which is a fact about consumption (larger houses with air conditioning) rather than about the reactor. |
| Terawatt (TW) | 1,000 GW | Every power station in America adds up to about 1.3 TW. China’s total is about 4 TW, roughly three times as much. The world’s entire generating fleet is somewhere above 10. |
The energy side of the ladder climbs the same way, and the numbers to anchor it are that the United States generates about 4,400 terawatt-hours of electricity a year and the world about 30,000. An American home gets through roughly 10,500 kilowatt-hours in a year.
The unit is named after James Watt, who appears again in Chapter 2 as the man whose separate condenser made the steam engine worth building. He also invented the horsepower, as a sales tool: a customer deciding whether to buy an engine wanted to know how many of the animals it would replace, so Watt gave them a number. One horsepower is about 746 watts, which makes a kilowatt a horse and a third. The word gigawatt dates from the early 1960s, when giga was adopted as an SI prefix, but its fame owes to a third source: the 1.21 gigawatts that Back to the Future needed to move a car through time, said on screen as “jigowatts”. Power markets use both the giga and the jiga pronunciation and the dictionary lists both, but the spelling is always giga.
What the buffer was doing
Storage does several distinct jobs in a commodity market, and power has to reproduce every one of them by other means. Electricity is sold by the megawatt-hour, which is a megawatt of output sustained for an hour, and is roughly what several hundred houses get through in that hour.
Table 1-2: What storage does, and what power has instead
| The job | Oil and nat gas | Electricity |
|---|---|---|
| Absorb a supply shock | Draw down inventory | Start a quicker-starting generator, or cut power to some customers on purpose |
| Move value across time | Store it and carry it forward | Mostly cannot, so a forward price is a forecast rather than the cost of holding something |
| Move value across space | Ship, pipe or rail it | Only along wires that already exist, and only inside one synchronised area |
| Let the price be wrong briefly | Inventory absorbs the error | Nothing absorbs it, so the price moves instead |
Cutting power to customers deliberately, which appears in the first row, is called shedding load, and it is the last defence rather than a routine tool. An operator who reaches that point has run out of generators.
The second row is the most obvious one traders from other commodity markets notice as a key difference. In oil, the shape of the forward curve, meaning the set of prices quoted today for delivery in each future month, is disciplined by arbitrage: if a distant month trades far enough above the front, somebody buys the front, pays for tankage and insurance and financing, and delivers into the distant month. That trade is what makes contango and backwardation, the two names for a forward curve sloping up or down, mean something physical. In power, for most of the curve, that trade does not exist. A megawatt-hour in January cannot be manufactured in October and held. So the forward price is somebody's estimate of what the last and most expensive generator needed on the day will cost, on a day nobody has seen yet, with no arbitrage available to discipline it.
Frequency is the balance sheet
The reason the frequency moves at all is that the system has mechanical memory. A large thermal or hydro plant spins a heavy mass of steel in step with the grid, and that rotating mass stores kinetic energy, which is simply the energy a thing has by virtue of being in motion. A spinning flywheel holds it. So does a moving train.
When demand suddenly exceeds supply, the first response is mechanical. The spinning machines physically slow down, giving up some of that stored motion to cover the gap, before any control system has acted. The frequency falls because the machines are decelerating.
That effect buys the operator seconds, and seconds are what the entire control hierarchy is built on. First the governors act: mechanical controls fitted to each machine that admit more steam or water when the machine senses itself slowing. Then automatic generation control, a signal sent from the control room that trims output across many plants at once. Then the operator, working by hand. And if all of that fails, protective relays, the automatic switches that disconnect equipment to save it from damage, begin cutting off customers in blocks to preserve what remains. This is the sequence a market design has to pay for, and Chapter 13 is about who gets paid to sit ready at each stage.
Grid frequency is the only quantity in commodities that is simultaneously a physical measurement, a real-time inventory report and a contractual obligation. When it falls, it is telling you the system is consuming its own stored motion to cover a shortfall.
This matters more than it used to because the mechanical memory is optional now. Wind and solar connect to the grid through an inverter, an electronic device that manufactures alternating current from a direct current source, rather than through a heavy spinning mass locked to the system. An inverter has no rotating parts, so it has no stored motion to surrender, and that stored motion is what engineers mean by inertia. That is a genuine engineering change, and it is the subject of Chapter 6. It is also, as that chapter will show, not the explanation for the blackout most people attribute it to.
The commodity that cannot travel
The second constraint is geographic, and it is more absolute than anything in oil or nat gas. Power flows only along conductors that already exist, meaning the metal cables built to carry it, and only within a single synchronous area. Synchronous here has its ordinary sense: every generator inside the area turns in lockstep, at the same frequency, like a very large set of gears that happen to be connected by wire rather than by teeth.
Between two such areas there is no direct connection, because two systems that are not turning in step cannot simply be joined without tearing machinery apart. North America runs as four separate synchronous areas: the Eastern Interconnection, the Western Interconnection, ERCOT covering most of Texas, and Quebec.
Power still crosses those boundaries, through direct current ties that convert alternating current to direct current, move it, and convert it back. Because direct current does not alternate, it has no frequency to match, which is what allows two systems with no common rhythm to exchange energy at all. It also means the transfers are small relative to the size of the systems, and that a generator in one interconnection is, for most commercial purposes, unavailable to a customer in another.
Why four rather than one is a fair question, and the answer differs by seam. Three of these boundaries exist because a synchronous machine that large is difficult to hold together, which the continent established by trying it: the east and west actually ran as one system from 1967 to 1975 and had to be separated again. The fourth, ERCOT, is a legal boundary rather than a physical one. Chapter 3 takes both up.
Readers of Commodities 101 will recognise the argument from the theme on logistics: for a whole class of markets the delivered price is created after extraction rather than at it. Electricity is the extreme case. A megawatt-hour is perfectly fungible with any other megawatt-hour on the same grid at the same instant, and completely unavailable to anyone anywhere else. There is no ship to charter, no route to reroute, no arbitrage to put on. There is only the wire, or no wire.
What follows from all this
Hold those two constraints together, instantaneous balance and captive geography, and most of what looks eccentric about power markets stops looking eccentric.
Prices go negative, meaning the seller pays the buyer to take the electricity away, which in any storable commodity would be an anomaly requiring a special explanation, and here happens thousands of hours a year as a structural feature. Prices spike to thousands of dollars in a single interval and return to normal an hour later. The same megawatt-hour is worth different amounts at two substations, the sites where high-voltage lines hand power down to local networks, a few miles apart. Regulators argue endlessly about whether the market pays enough to build a plant that will run four days a decade. Every one of those is a consequence of having no inventory and no exit.
It also explains why there is no single world price for electricity, and never will be. Oil has one. Nat gas has been converging toward one as liquefaction turned a piped commodity into a shipped one. Power has dozens of prices that cannot be arbitraged against each other in any meaningful sense, and the differences between them come from different answers to the same engineering problem, written by different regulators in different decades.
Which is the argument of this book. Every market design in the chapters ahead, nodal or zonal, energy-only or capacity-paying, dispatched by an independent operator or by a vertically integrated utility, is an attempt to solve one problem: you cannot store the product, so you must arrange, in advance and by contract, for exactly the right amount of it to exist at exactly the right instant, in exactly the right place. Nobody has solved that cleanly. The rest of this book is about how differently people have failed to.