What Are Wholesale Electricity Markets?

Wholesale electricity markets are the platforms where generators sell power and utilities buy it before delivering it to homes and businesses. Unlike most commodities, electricity cannot be economically stored in large quantities, so supply must match demand in real time. Wholesale markets solve this coordination problem by running continuous auctions that dispatch the lowest-cost generators first.

In the United States, wholesale markets are operated by regional transmission organizations and independent system operators. About two-thirds of the country’s electricity flows through these organized markets. The remaining third is served by vertically integrated utilities that own their own generation and do not participate in competitive markets.

Day-Ahead and Real-Time Markets

Organized wholesale markets operate in two primary timeframes. The day-ahead market runs the afternoon before each operating day. Generators submit offers specifying the price at which they are willing to produce electricity for each hour of the following day. Load-serving entities submit bids indicating how much electricity they expect to need. The market operator runs an optimization algorithm that selects the lowest-cost combination of generators to meet forecasted demand.

The real-time market runs continuously during the operating day, typically clearing every five minutes. It handles deviations between day-ahead schedules and actual conditions. If demand is higher than forecast or a generator trips offline unexpectedly, the real-time market dispatches additional resources at the prevailing real-time price.

Locational Marginal Pricing

Most US wholesale markets use locational marginal pricing, or LMP. The price of electricity varies by location on the grid, reflecting not just the cost of generation but also transmission congestion and losses. A generator located near a major demand center might receive a higher price than an identical generator in a remote area where transmission lines are congested.

LMP creates price signals that guide investment decisions. High prices at a particular location signal the need for new generation or transmission capacity there. Low or negative prices signal oversupply. These signals drive where developers choose to build new power plants, solar farms, and battery storage systems.

The Merit Order and Price Formation

Generators are dispatched in order of their marginal cost, a concept known as the merit order. Nuclear and renewable generators, which have near-zero fuel costs, are dispatched first. Natural gas plants with moderate fuel costs come next. Oil-fired and older coal plants with the highest operating costs are dispatched last, only when demand is high enough to require them.

The market-clearing price is set by the last generator dispatched to meet demand, known as the marginal unit. All generators dispatched in that interval receive this same price, regardless of their individual costs. This means low-cost generators earn a profit margin above their operating costs, while the marginal generator roughly breaks even.

Capacity Markets and Resource Adequacy

Several regions supplement their energy markets with capacity markets. These markets pay generators for committing to be available during peak demand periods, whether or not they actually produce electricity. The goal is to ensure that enough generation capacity exists to meet demand even during extreme conditions.

PJM, ISO New England, and NYISO all operate capacity markets. ERCOT and CAISO do not, relying instead on energy market price signals and administrative mechanisms to ensure resource adequacy. The debate over whether capacity markets are necessary or distortive remains one of the most active policy discussions in the electricity sector.

How Renewables Are Changing Market Dynamics

The rapid growth of wind and solar generation is reshaping wholesale market economics. Because renewables have zero marginal cost, they push higher-cost generators out of the merit order and reduce wholesale prices. This phenomenon, sometimes called the merit order effect, benefits consumers through lower electricity costs but challenges the economics of conventional generators that need higher prices to remain profitable.

Negative prices are becoming more common during periods of high renewable output. In ERCOT and CAISO, wholesale prices regularly go negative during sunny or windy afternoons, meaning generators must pay to put electricity on the grid. Battery storage is increasingly positioned to exploit these price swings, charging when prices are low or negative and discharging when prices rise during the evening peak.