How does the electricity market work?

Electricity is produced by various companies operating thermal, wind, hydro, and solar power plants, then transported through regulated transmission and distribution grids, and finally delivered to end users by retail suppliers.

The Spanish electricity market is a structure composed of multiple markets where electricity generators sell energy to retail companies, which in turn supply it to final customers. 

The system is designed to ensure that electricity supply and demand are balanced at all times.

The day-ahead market

The day-ahead market is the main trading platform for electricity in the Spanish peninsula (excluding the islands, Ceuta, and Melilla). Participation in that market is obligatory for all available generation units not under bilateral contracts. It is managed by OMIE, the designated electricity market operator.

Below, we can see key features of the day-ahead market:

• Mandatory participation for all available generation units not under bilateral contracts.
• Hourly matching of supply and demand for every hour of the following day (i.e., 24 hourly prices are set daily).
• Marginal pricing model. That means that all generation units (sellers) receive the same unit revenue of the last unit matched for each hour, while all retailers (buyers) pay that same price.

Supply is planned based on projected demand and the expected generation from each technology. Renewable sources—due to their minimal variable costs—generally offer cheaper electricity than thermal generation (nuclear or combined cycle), which depends on fuel costs. 

The Spanish day-ahead market and its European integration

Market clearing is carried out within the broader European market. An algorithm calculates the hourly electricity price for each country the day before.

European countries use this day-ahead market to import or export electricity to cover their demand at the best possible price, depending on the available transmission capacity (i.e., the amount of energy each country can handle).

The organisation CORESO determines real-time grid capacity across Europe, factoring in variables such as weather conditions. Countries can isolate themselves by severing interconnections if needed.

Additional services

The day-ahead market’s outcome dictates the electricity generation schedule for the following day, optimising for economic efficiency—in other words, the lowest-cost generation sources win the auction.

This schedule is sent by OMIE to Red Eléctrica (Spain) and REN (Portugal), the system operators, who assess whether the plan is technically feasible.

System operators must answer two key questions the day before:

• Is the electricity generation schedule technically feasible? To answer the question, we need to consider:
• The configuration of transmission and distribution grids.
• The location of demand.
• The location of supply.
•  Does the system have the capacity to handle any failure?

To ensure supply security, system operators activate additional markets based on the system’s real-time needs.

The technical constraints market 

The technical constraints market is activated when necessary to maintain security standards and address weaknesses in power generation or transmission (e.g., grid overloads—within the domestic grid or international interconnections—or improper voltages).

Adjusting for constraints may modify the market-clearing schedule and result in additional costs of overall electricity prices.

Secondary regulation services

This service provides fine-tuning of grid frequency, which is a critical signal of whether the system is balanced. In Europe, grid frequency is standardised at 50 Hz.

The secondary regulation service automatically adjusts generation (via up/down commands) to correct frequency deviations and manage international exchanges—this is done via control centres communicating with generation plants. 

Real-time balancing markets

To manage unforeseen events, a separate mechanism exists: the reserve market. These are known as real-time technical constraints and help address the question: 

Does the system have the capacity to handle any failure? Scenarios include:

• A sudden spike in demand.
• Failure of a large generation unit.
• Lack of expected wind generation.

Conversely...

• Overgeneration due to snowmelt or higher-than-expected wind.
• Drop in demand due to a major consumer outage.

Thermal units are often used in these situations due to their operational flexibility. System operators may order an increase or decrease in power output.

Electricity generation must constantly adapt and fulfil any system requirement. All of these market layers work in tandem toward a common objective: to balance supply and demand at all times and guarantee a stable, secure electricity supply for all consumers across the Iberian Peninsula.