The traditional view of the electricity supply chain is something like: Generators → Transmission & Distribution → Retailers → Consumers.
Every other participant in the supply chain, including consumers (as ‘prosumers’), are involved in the physical creation or transportation of electricity.
But retailers are literally selling a product they never physically touch. So, if they aren’t part of the physical supply of electricity what exactly do they do?
A complex bundle of services
Retailers don’t just re-sell us energy they have sourced from generators (and prosumers). They also re-sell:
- Network services, transmission and distribution, which is the use of the infrastructure that transports energy from generators to consumers;
- Electricity system services, sometimes called essential or ancillary services, which ensure we have a stable and reliable electricity system;
- Electricity system and market operations, usually provided by an independent third-party responsible for managing the electricity system;
- Generation capacity, which ensures there are enough generators being built to meet our energy requirements when demand peaks;
- Environmental certificates, which are used for funding renewable energy and energy efficiency schemes; and,
- Electricity metering, which is fundamental to making the whole system work.
These services are all provided by different underlying suppliers.
For example transmission and distribution infrastructure is owned by regulated utilities who will have a monopoly on providing network services in one of the many different regions the retailer might operate, and who will all price their services in (sometimes baroquely) different ways.
The power plants which generate electricity are owned by a myriad of independent power providers, or in some cases by vertically-integrated retailers themselves, and in some less deregulated markets by vertically-integrated ‘utilities’, who also own the transmission or distribution infrastructure.
All of these services are subject to complex regulations, have complex contracting arrangements, and have complex, and often highly dynamic, pricing.
Retailers serve to simplify the billing process by providing one consolidated monthly or quarterly bill, instead of consumers receiving half a dozen individual bills from different organisations.
So one of the jobs of retailers is to turn these bundles of services into simple retail products that consumers can understand and buy and pay for easily.
A volatile commodity
While all of these services have complex pricing, the energy commodity itself can have particularly dynamic, even volatile, pricing.
For example, in Australia’s National Electricity Market (NEM) the wholesale price of energy can go as low as negative $1000 (i.e. you can be paid for consuming energy) and as high as around $15,000 (for a megawatt-hour of electrical energy). And not only is this price range very wide, the physical commodity settles in 5-minute intervals so it’s possible for there to be wild swings in price over very short periods of time.
The reason for this extreme volatility is that electrical energy is a unique physical commodity. It moves at close to the speed of light, and supply and demand have to be perfectly balanced in real-time or the system can go black.
We are moving from a world where most generation was firm (and expensive and emissions-intensive) to a world where more and more generation is variable (and cheap and emissions-free).
While variable renewable energy is providing the cheapest energy in history, it is also creating more complex market conditions where we need to be able to accurately forecast renewable output, as well as customer load, to keep supply and demand in balance.
So the next job of retailers is to take a volatile and uncertain price and turn it into a fixed, simple and low price for electricity (and still make a profit).
Another key role of retailers is to be financially responsible to all of the other participants in the electricity system for the electricity used by their customers. Effectively retailers have to meet all of the prudential requirements of the electricity system.
They take on all the credit risk on behalf of all the other players. If the customer pays their bill late (or never pays their bill at all), the retailer still has to pay the generators and networks and everyone else who is providing the underlying services that the retailer is ‘on selling’ to you and me. This credit risk is significant, and retailers have gone broke because of it.
In every trading interval, the retailer must have contracted the supply of energy to match the load of all of its customers. Any imbalance between contracted supply and customer load is settled in a physical market by the system operator, and the retailer must have enough credit support to enable this financial settlement to occur.
The role of trading
Retailers are under competitive pressure to offer their customers low energy prices. Their business is to build a retail customer book and to build a wholesale position to match the load in that customer book.
Their wholesale position could be to just let all of their customer load settle in the (last-minute) physical market, but if they want to be commercially competitive they can use trading to build a lower-cost wholesale position, and thus be able to offer lower retail prices and compete successfully against other retailers.
Retailers will analyse their customer book to determine the size and shape of their customer load and to forecast how it will grow and change over time, and then they will seek to contract supply to match this.
At the opposite extreme to last-minute settlement in the physical market, is entering into long-term power-purchase arrangements (PPAs) with independent power providers (or in the case of vertically-integrated gentailers, building their own power stations). These PPAs might provide a fixed volume and shape of energy generation at a fixed price over a long period of time.
Retailers can also enter into long-term bilateral agreements with other market participants: generators, demand response providers, other retailers, and even pure wholesale traders helping provide depth and liquidity to the market.
There are also futures markets for energy, like we see for commodities like soybeans and pork bellies, and even exotic products like weather insurance that will ‘pay out’ if certain events occur (like a long series of hot days in a row, which could drive up energy prices). And some market jurisdictions, like Western Australia’s WEM, have a short-term day ahead markets where retailers can trade before the last-minute balancing or physical spot market.
By taking a view on their future load requirements, and contracting supply and trading with other market participants, retailers cause more generation to be built or to be running at the right time and thus ensure electricity supply and demand is matched at a lower cost.
Distributed Energy Resources
So we see on the one side that retailers create simple retail products with fixed pricing for consumers, managing risk and volatility on their behalf; and on the other side, they guarantee payment to the rest of the electricity system, and help balance supply and demand through wholesale trading.
But we are now in a new world where more and more consumers are generating energy themselves with roof-top solar, and deploying other distributed energy resources (DERs) like battery storage and smart flexible loads (like electric vehicles and bi-directional charging, which is both of these things). These new technologies provide another way to balance supply and demand and manage price risk and are blurring the lines between retail and wholesale.
In the old world, retailers would forecast the size and shape of their customers’ load and go off looking for supply to match. But in the new world customers can provide retailers with a supply-side solution and customers’ loads can be almost any shape they want (which makes the traditional approach retailers take to retail prices particularly challenging).
The opportunity now is not to match firm generation to variable load, but to match variable generation to flexible load.
Some retailers are responding to this challenge by enabling customers direct access to the wholesale market, passing the responsibility to manage risk and volatility back to the customer. Others are taking the opportunity to bundle energy solutions with electricity supply and to reimagine demand response and the way it can fit into their trading strategy.
And others still are envisioning a new kind of power plant made up of thousands of customer DERs aggregated together that participate in the market in exactly the same way as traditional large scale generators. These ‘virtual power plants’ might bid into the market and be dispatched by the system operator just like coal and gas power plants, all coordinated by new digital technology.
At Gridcognition, we see the balance of energy shifting from large-scale centralised generators, to small-scale distributed energy resources. And this shift is creating challenges and opportunities for all the players in the electricity system.
For retailers this is creating an imperative to build new analytical capabilities (like Gridcognition) and new organisational models that better integrate the retail sales and wholesale trading parts of their business, to fully take advantage of the opportunities of distributed energy, and the digital and decarbonised future that is just around the corner.