An electricity market is an organized system where various participants—such as power generators, retailers, and large consumers—buy and sell electrical energy. Unlike most other goods, electricity cannot be stored easily in large quantities, meaning it must be generated and consumed simultaneously. This characteristic makes managing the electricity market more complex and gives it unique features.
Types of electricity markets
Electricity markets are categorized according to the time frame in which transactions occur:
- Day-ahead market (spot market): Supply and demand bids are matched for each 15-minute interval of the following day.
- Intraday markets: Enable participants to adjust their positions closer to the actual time of delivery.
- Forward and futures markets: Allow trading of electricity contracts for future delivery, ranging from days to several years in advance, at agreed prices.
- Balancing and ancillary services markets: Operate in real time to maintain system stability and reliability.
Liberalization of the electricity sector
Before the 1990s, electricity systems in most European countries were controlled by state-owned or vertically integrated monopolies. Prices were regulated, and consumers had no choice of supplier. Beginning in that decade, the European Union initiated the liberalization of the electricity sector to create a single European energy market.
Liberalization opened electricity generation and retail supply to competition, allowing consumers to choose their provider. Transparent wholesale markets were established, and regulated activities—such as transmission and distribution—were separated from competitive ones like generation and retailing. In Spain, this process was formalized under the Electricity Sector Act of 1997, which introduced the wholesale market operated by OMIE (Iberian Energy Market Operator).
How electricity prices are set
In the day-ahead market, generators submit offers to sell electricity at specific prices for each 15-minute period of the next day, while retailers and large consumers submit bids to buy electricity. The market operator—OMIE in Spain and Portugal—matches supply and demand by arranging offers from lowest to highest price and bids from highest to lowest until the required quantity is met.
The clearing price, or marginal price, is determined by the last (most expensive) technology needed to meet demand. This method, known as the marginal pricing system, is a standard under European law. For example, if demand is covered by wind, hydro, and gas generation, the price paid to all producers equals the offer made by the last accepted technology, even if others offered lower prices. This approach rewards efficient, low-cost producers and encourages competition.
The marginal pricing model is considered the most efficient because it reflects the actual cost of producing the final unit of energy required to meet demand. All generators receive the same market price, motivating them to bid competitively. The system promotes transparency, competition, and economic efficiency, ensuring that electricity is generated at the lowest total cost.
Alternative systems, such as pay-as-bid, where each producer is paid the price they offered, are less efficient because they incentivize participants to bid higher, just below the expected marginal technology price.
Consistency across Europe
The marginal pricing model ensures harmonization across European electricity markets, allowing for consistent price comparisons, effective risk management, and coordinated investment planning. Abandoning this framework could lead to market fragmentation, price uncertainty, and instability in investment signals.
Electricity futures markets reflect expectations of day-ahead prices over future periods. Since these contracts are settled against day-ahead prices, the marginal pricing system directly influences future price levels and volatility. Any change in this system would alter the entire price structure, affecting financial contracts, risk management, and investment decisions across the electricity sector.
The role of retailers
Retailers purchase electricity from the wholesale market and sell it to end consumers. They may be part of established utility groups or operate as independent suppliers. Following liberalization, consumers gained the right to choose their retailer. There are typically two main types:
- Free-market retailers, which offer customized prices, services, and contracts.
- Regulated or reference retailers, appointed by governments to provide tariffs at regulated rates.
Interconnected markets and European integration
A key goal of liberalization has been to create a single European electricity market through physical interconnections and harmonized regulations. These interconnections allow countries to import or export electricity depending on supply and demand, improving efficiency, price convergence, and energy security.
Spain and Portugal form the MIBEL (Iberian Electricity Market), which is connected to France and, indirectly, to the broader European network.
Advantages and challenges of a liberalized system
The liberalization of the electricity market has brought multiple benefits:
- Greater price transparency.
- Consumer choice of supplier.
- Stronger competition among generators and retailers.
- Enhanced efficiency and innovation.
However, it also presents challenges:
- Protecting vulnerable consumers.
- Managing price volatility.
- Simplifying complex systems for less-informed customers.
- Ensuring regulatory and technical coordination among countries.
Liberalization represents one of the most significant transformations in Europe’s energy landscape. Today, with the large-scale integration of renewables, growing electrification of demand, and rapid digitalization, the European electricity market is entering a new phase of evolution, AleaSoft reports.
