While many investors are familiar with mainstream investment markets, few know about the option to trade power in the electricity market. This endeavor can be lucrative, but it also requires in-depth knowledge about electrical grids and usage trends. There are some unique aspects to electricity trading that sets it apart from forex or share trading, which we’ll examine below.
In fact, power trading is risky and complex for two main reasons. The first reason is that power demand changes from minute to minute due to supply and demand dynamics – and so does the price. But investors have to lock in their monetary investment before electricity is used.
The second reason is that electricity cannot be stored. If you trade power and the electricity travels down the wires but never gets consumed, that investment cannot be recovered. Keep reading to learn a little more about this complex system.
Understanding the grid
Power grid is basically made up of the network of transmission and distribution facilities. Usually, electricity is transmitted at an elevated voltage over the powerlines stationed all around the countryside. As higher the voltage, then less current is needed for the same amount of power, which leads to less of electricity loss.
The power grid in the United States for example, isn’t a single grid at all. It’s actually three distinct grids that can be further broken down. There’s the eastern grid, the western grid, and the Texas grid. There’s been a long history of policy changes and debate about whether or not electricity companies should compete over consumers in the same region, which led to the development of ISOs.
Independent system operators
Independent system operators, or ISOs, are hubs for electricity. When power plants generate electricity, the ISOs act as middlemen. They’re responsible for dispatching power where it needs to go and ensuring there aren’t any power outages.
ISOs also serve as localized stock exchanges. There are just seven ISOs in the continental US. When power traders want to invest money and predict where the power goes, an ISO must facilitate it.
Load serving entities
Load serving entities, or LSEs, are where the power is transferred to. They serve much smaller areas, such as neighborhoods. When the demand for electricity is high, LSEs risk running out of power supply through congested lines. In this case, LSEs may request power from distant ISOs to stave off power outages.
Options for trading and determining prices
So, where exactly does power trading come into play, and how do traders benefit from this venture? Electricity trading occurs on the path from the power plant to the consumers. Investors carefully monitor the available power supply and operating cost of power plants. They also keep an eye out for reasons for greater power demand, like severe weather.
An investor can buy into the future cost of power. Locational marginal pricing (LMP) is shorthand for how much the next megawatt of power is going to cost at a given point. A trader can invest in what they think the next LMP point may be.
If an affordable ISO isn’t able to provide power to an LSE, a different ISO can dispatch power. Higher dispatch costs from the increased demand – offloaded to either the LSE or the consumer –benefit the trader. This complex process goes on every day, but it takes a keen eye to sort it all out.