How does power grid congestion affect energy prices?

How does power grid congestion affect energy prices?

When electricity prices change dramatically from one region to another, it's often not fuel costs or demand that are to blame, but rather the invisible limits of the transmission grid. Think of power lines as the arteries of our energy system. When they become congested, cheap power can't reach where it's needed, and more expensive units are brought online, resulting in more fragmented market prices. By understanding how this process works and its contribution to market volatility, curtailment, and constraint costs, we can better appreciate the complexities of today’s power markets.

What is grid congestion and why does it matter?

Power grid congestion happens when transmission bottlenecks block the cheapest available generation from meeting demand. Ideally, the electricity system works on a merit order, starting with low-cost renewable or conventional generators and adding more expensive ones as needed. However, when constraints restrict flow across important transmission lines, cheaper energy can get stuck behind the bottleneck, and the more expensive local units end up determining the market price.

This situation has several knock-on effects.

In import-constrained regions, local prices can sometimes climb quite high, especially as conditions shift from hour to hour, making the situation more volatile. Renewable generators might need to be curtailed when their output can't be exported, which can lead to inefficiencies in how the system runs and impacts investment returns. Overall, congestion acts like a traffic jam for the system, stopping it from working at its best and increasing costs for everyone involved, including consumers and market participants.

How does congestion show up in prices?

In markets with locational marginal pricing (LMP), like those in the US and some European pilot programs, each node's price includes the cost of energy, congestion, and transmission losses. As a result, two nodes located just a few kilometres apart can have significantly different prices when a transmission line between them is congested. While LMP offers transparency, it also brings complexity and volatility.

Other systems adopt zonal pricing, where prices are uniform within broad regions. In these markets, intra-zonal bottlenecks do not appear directly in nodal prices but instead surface as redispatch costs borne by the system operator. This makes prices appear more stable but hides the actual cost of congestion.

Price spreads also influence market risk. During periods of limitation, day-ahead prices can differ greatly from real-time outcomes, creating basis risk for traders, suppliers, and corporate buyers. Understanding how and when these differences happen is vital for managing exposure.

Renewable hotspots and curtailment dynamics

Congestion problems are especially severe in areas rich in renewable energy. Export-limited regions with high levels of wind and solar often experience curtailment when transmission lines become overloaded. Instead of supplying demand centres, output is reduced or completely shut down.

This can lead to negative prices, where oversupply behind a constraint pushes prices to fall below zero. Generators may be willing to pay to stay online if subsidies or support schemes reward production, while consumers benefit from cheaper power if they can use it at the right time and place.

Curtailment and negative prices exhibit different seasonal and hourly patterns. Windy winter nights, bright midday summer hours, and maintenance outages on important transmission lines can cause sudden local imbalances. For investors and operators, understanding these patterns is essential to accurately project economic outcomes.

Market tools used to manage congestion

System operators use various market tools to ensure grid security during congestion. Redispatch and countertrading involve rescheduling generators to alleviate constraints, typically paying some units to reduce output and others to increase it. Although effective, this method results in substantial uplift or constraint costs, which are then shared among market participants.

At the cross-border level, flow-based market coupling and interconnector allocation help facilitate smoother and more efficient transfers between countries while ensuring that security margins are maintained. By understanding how power naturally flows, these methods make better use of existing capacity and help cut down on hidden congestion costs, making the whole system work more effectively.

Financial tools also have a significant role. Congestion revenue rights (CRRs) or financial transmission rights (FTRs) enable market participants to hedge against congestion risks between nodes or zones. These contracts turn volatile spreads into predictable payments, helping suppliers, traders, and buyers manage their exposure to locational price differences.

Operational fixes that reduce congestion costs now

While significant grid investments take years, several operational measures can ease congestion in the short term.

Demand response

Demand response shifts consumption away from constrained hours or locations, smoothing peaks and lowering flows across bottlenecks.

Battery storage and hybrid assets

Battery storage and hybrid assets absorb local surpluses and discharge during peaks, acting as a buffer between generation and demand.

Topology optimisation and dynamic line ratings

Topology optimisation and dynamic line ratings assist system operators in maximising capacity from current infrastructure by re-routing flows or permitting increased line usage when weather conditions allow.

These interventions may not remove congestion entirely, but can cut the cost of managing it while longer-term solutions are developed.

Investment and planning that solve the root cause

Ultimately, resolving chronic congestion necessitates structural changes. Reinforcing the grid and adding new transmission lines along main corridors are the most straightforward solutions, although they face challenges regarding planning, cost, and public acceptance.

Another approach is generator and load siting: encouraging new demand, storage facilities or flexible generation to locate close to renewable resources, reducing the need for long-distance transmission. Long-duration storage can also play a role by absorbing excess power for days or weeks and releasing it when transmission capacity is available.

Finally, expanding the interconnector increases system diversity and enables regions to share resources, reducing volatility and distributing the cost of balancing across larger markets.

What does congestion mean for market participants?

For various participants in the energy market, congestion presents both risks and opportunities.

• Generators face lost revenue when output is curtailed, though flexible peaking plants in import-constrained zones can benefit from higher prices.

• Suppliers and large consumers must hedge basis risk using tools such as FTRs/CRRs, virtual PPAs, or nodal-aware procurement strategies.

• Developers need to account for curtailment risk and locational spreads when assessing project bankability and negotiating PPA prices.

In each case, ignoring congestion can undermine economic efficiency, while actively managing it can unlock a competitive advantage.

Measuring congestion and tracking signals

Understanding congestion requires careful monitoring of indicators. Key signals include nodal and zonal price spreads, curtailment hours, redispatch spending, and constraint rent.

Data sources like day-ahead versus real-time price gaps, interconnector flows, and published outage schedules offer valuable foresight. Additionally, congestion maps and forward-looking forecasts are becoming more accessible, enabling market participants to plan their operations, hedges, and investments more confidently.

Power grid congestion can significantly impact energy prices, as it blocks affordable power from reaching demand centres. This can lead to higher local costs, wider price differences, curtailment, and increased volatility. Fortunately, markets have ways to reveal and manage these effects through mechanisms like LMP, redispatch, and financial transmission rights. Additionally, operational tools such as storage and demand response help to ease these impacts in the short run, providing some relief.

In the long term, strengthening the grid, selecting optimal locations for generation and load, building stronger interconnectors, and incorporating flexible assets are all crucial steps in addressing the underlying issues. For market participants, being aware of nodal details is critical to recognising and hedging congestion risks. With the correct information, congestion shifts from being a problem to a manageable cost on our journey toward a more renewable and interconnected energy system.