Electricity Markets
Electricity Markets
A Comprehensive Exploration of the Spanish (and Broader European) Electricity Market
Electricity markets in Spain—and throughout Europe—operate through a series of auctions andmechanisms that progressively refine the balance between supply and demand, from the day beforedelivery all the way to real-time. This step-by-step chain includes day-ahead auctions, intradayadjustments, balancing (reserve) services, and final imbalance settlements. While the day-ahead andintraday markets establish baseline and updated schedules, the balancing (or ancillary) services ensuresystem stability in real time. Although each segment is distinct in timing and pricing methodology, theyinterlock to form a coherent system. Below is an in-depth exploration of how they work, why different pricesignals exist, and how market participants—from power generators to retailers, large consumers, andtraders—navigate these opportunities.
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Market Structure and Timeline
Day-Ahead Market (D-1)
The day-ahead market is the foundational auction through which most energy is bought and sold. InSpain, this auction is administered by OMIE and typically closes around midday on the day beforephysical delivery (D-1). Producers, retailers, large consumers, and traders submit bids and offers for eachhour of the following day (D). The system uses a marginalist mechanism: every hour’s price is set by thehighest-cost accepted offer needed to satisfy demand at that hour.
This market serves as the principal reference for electricity prices. It is generally less volatile than real-timemechanisms, since it captures the best forecasts available one day in advance. However, significantchanges in demand (e.g., extreme weather events) or unexpected supply constraints (e.g., generatoroutages) can cause the day-ahead price to spike.
Intraday Trading
Auctions
Continuos
After the day-ahead auction closes, market participants often need to adjust their positions due to newforecasts or unexpected events. Spain historically employs multiple intraday auctions—up to six in atypical day—allowing refinements to the day-ahead positions. These sessions use a marginalist approachsimilar to the day-ahead market, but they occur progressively closer to real-time.
Once the final intraday auction concludes, continuous trading takes over, typically up to about one hourbefore delivery. In this continuous market, buy and sell orders are matched instantaneously on anelectronic platform. Prices here can be more volatile than at earlier stages, reflecting the market’s responseto last-minute changes—such as wind forecasts shifting or a sudden industrial consumption spike.
Balacing Services
mFRR
aFRR
Even after the intraday market closes, the system operator (Red Eléctrica de España, or REE, in Spain) hasultimate responsibility for balancing supply and demand in real time. To maintain frequency and reliability,REE relies on several ancillary services:
Secondary Reserve (aFRR): Automatically adjusts generation or consumption within minutes to correctfrequency deviations.
Tertiary Reserve (mFRR): Manually dispatched if secondary reserve is insufficient or if imbalancespersist; typically activated within minutes to half an hour.
Imbalances (Ex Post Deviations): After the fact, participants’ actual generation or consumption iscompared to their scheduled nominations. Any shortfall or surplus is settled through an imbalance price,which is often punitive compared to proactive correction in the intraday market.
Balancing services ensure that any deviation from the schedule—even minutes or seconds before real-time—is quickly addressed, preventing large-scale frequency or voltage problems.
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Price Formation and Cost Dynamics
Comparing Day-Ahead, Intraday and Balancing Prices
Prices tend to be more volatile as one moves closer to delivery because the ability to respond on short noticerequires flexibility and the lack of liquidity. The day-ahead market offers relatively stable price signals, while intraday auctions andespecially continuous trading can exhibit sharper movements as new information emerges. Balancingservices, by design, command higher remuneration for quick or automated responses. The further inadvance an agent corrects its position (i.e., in day-ahead or intraday), the lower the likely cost ofalignment.
Imbalances as a Costly Last Resort
When a market participant’s actual generation or consumption differs from the scheduled plan, theresulting imbalance is settled at the imbalance price. This mechanism is deliberately set to be lessfavorable (sometimes significantly so) than voluntary market trading, incentivizing accurate forecastingand proactive position management. Whether an agent ends up paying or receiving depends on whetherthe system as a whole needs additional energy (short system) or has excess (long system).
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Participation of Different Market Agents
Generators and Consumers
Generators typically sell the majority of their output in the day-ahead market, adjusting in subsequentintraday sessions if forecasts or operational constraints change. Large consumers (e.g., industrial facilities)may similarly purchase the bulk of their electricity in day-ahead, fine-tuning their positions intraday. Bothgenerators and consumers can offer balancing services if they meet the technical requirements set by thesystem operator.
Retailers and Traders
Retailers buy power on behalf of their end customers and must ensure the aggregate offtake matchesthose customers’ consumption patterns. Traders, on the other hand, may buy and sell electricity toarbitrage price differences across different markets (for example, day-ahead vs. intraday) or acrossdifferent geographies. In balancing services, participation generally requires specific technical capability,so traders often have a more limited role unless they have dispatchable assets or demand-response portfolios.
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Focus on Balancing Services
Balancing services in Spain (and across many European countries) ensure that the system can respondquickly and effectively to sudden fluctuations. Although they are collectively known as “reserves,” theyinvolve two distinct components for each participant:
Offering Reserve Capacity (being available if called upon).
Supplying or Withholding Energy (when activated).
Reserve Capacity Tenders: Marginal Auction
Spain uses marginal auctions to secure reserve capacity for both secondary (aFRR) and tertiary (mFRR)reserves. Here, market participants submit offers indicating how many megawatts (MW) they can provideand at what price per MW of availability. The system operator accepts the most economical offers untilthe required volume is reached. All successful bidders then receive the marginal price—the rate offered bythe most expensive accepted bid. If, for instance, you offer capacity at 50 €/MW and the marginalclearing price ends up at 60 €/MW, you receive 60 €/MW for that capacity, regardless of your original lower offer.
Activation of Energy: Pay-As-Bid
Once the capacity is secured, REE only calls upon the energy from those providers if and when it is needed(e.g., a drop in system frequency or a sudden imbalance). The pricing structure for energy activation inSpain typically follows a pay-as-bid model. This means each provider is paid exactly the price they offeredfor the MWh delivered, rather than a uniform marginal price. If you bid 200 €/MWh for activation, and youare selected, you receive 200 €/MWh, irrespective of whether another provider had a higher or lower price.
Order of Activation
When an imbalance arises, REE activates resources starting with the lowest-cost offers first, movingupward until the required volume is obtained. Thus, although each provider is paid according to its ownbid, the order in which they are activated depends on the relative attractiveness of their offer.
Strategic Implications
Generators or large consumers offering balancing services therefore have an incentive to keep theircapacity bids low (to ensure selection) while balancing their desire for higher energy-activation pricesagainst the risk of not being activated if the price is too high. This dynamic encourages a carefuloptimization of capacity and energy bids, reflecting both the likelihood of being called and the potentialrevenue from pay-as-bid activation.
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Capacity Markets for Long-Term Security
Once the capacity is secured, REE only calls upon the energy from those providers if and when it is needed(e.g., a drop in system frequency or a sudden imbalance). The pricing structure for energy activation inSpain typically follows a pay-as-bid model. This means each provider is paid exactly the price they offeredfor the MWh delivered, rather than a uniform marginal price. If you bid 200 €/MWh for activation, and youare selected, you receive 200 €/MWh, irrespective of whether another provider had a higher or lower price.
Order of Activation
When an imbalance arises, REE activates resources starting with the lowest-cost offers first, movingupward until the required volume is obtained. Thus, although each provider is paid according to its ownbid, the order in which they are activated depends on the relative attractiveness of their offer.
Strategic Implications
Generators or large consumers offering balancing services therefore have an incentive to keep theircapacity bids low (to ensure selection) while balancing their desire for higher energy-activation pricesagainst the risk of not being activated if the price is too high. This dynamic encourages a carefuloptimization of capacity and energy bids, reflecting both the likelihood of being called and the potentialrevenue from pay-as-bid activation.
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Imbalances and Settlement Ex Post
After real-time, each participant’s actual generation or consumption is measured, and any deviation fromthe nominated schedule results in an imbalance. The price associated with these imbalances can be morepunitive than in the voluntary markets. For instance, if the system operator had to activate expensivetertiary reserves to cover a shortfall, participants who under-produced (or over-consumed) might pay anelevated imbalance price. Conversely, those who over-produced in a short system could be compensated,but again, the price is set by system conditions and rules, typically making it more expensive to rely on theimbalance mechanism than to adjust in earlier markets.
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Observations
Early Alignment Saves Costs
The earlier a participant corrects its position—be it in the day-ahead or intraday markets—the cheaper itgenerally is. Intraday auctions and continuous trading help refine positions, but waiting until real-timebalancing or relying on imbalances can be costly.
Flexibility Commands a Premium
Balancing services, particularly secondary and tertiary reserves, offer higher remuneration to thosecapable of rapid or automated responses. This premium reflects the technical requirements and the valueplaced on system stability.
Distinction Between Capacity and Energy Pricing
Spain’s two-tier approach—marginal pricing for reserve capacity, pay-as-bid for activation—can lead todifferent bidding strategies. Offering a low capacity price boosts the chance of selection, but a highenergy activation price may reduce the likelihood of dispatch.
Long-Term Adequacy Through Capacity Mechanisms
Separate auctions ensure sufficient generation (and responsive demand) in the medium to long term,safeguarding the grid against shortfalls during peak demand or unforeseen outages.
By comprehending these various layers—day-ahead scheduling, intraday refinements, real-time balancing,and final imbalance settlement—market participants can optimize both their operational and financial outcomes. These mechanisms, though intricate, align well with the ultimate goal of delivering reliable electricity at least cost, while incentivizing the flexibility and innovation needed in a rapidly evolving energylandscape.