Some customers also paid rates that reflected the different cost of supplying electricity at different times of the day. When demand for power is high, such as in the late afternoon on a sweltering hot day, utilities need to operate small, so-called "peaking units" that often are more expensive to operate than the big coal or nuclear "base-load" units that run 24 hours per day. The higher cost is reflected in a higher rate.

In both cases, electricity could not technically be called a commodity--an undifferentiated product used in large quantities--because its price depended on the maximum amount of electricity demanded or the time of day a customer used that power.

The Role of Power Marketers

Power marketers have recently entered the utility industry and have made electricity more of a commodity for buyers. Different from utility companies, marketers have no financial stake in the assets used to generate electricity. They buy energy and transmission services from traditional utilities and resell electricity to other utilities or distributors of power. By purchasing power from numerous sellers, marketers can take advantage of the price disparities of various utilities and sell it as a commodity.

For example, if one utility has a peak cost of 5 cents per kwh and off-peak cost of 3 cents, it could offer an average rate of just above 4 cents to make a profit. Another utility's cost structure might have a peak cost of 5.5 cents and off-peak cost of 2 cents, thus being able to offer a price of slightly more than 3.75 cents. If only these two utilities offered these prices to customers, then all would choose the second utility. But the power marketer would buy power from both companies and combine the peak and off-peak prices, yielding a delivery price of 3.5 cents per kwh, thus besting the offering price of either utility.

Though a simplified example, it nevertheless demonstrates that the marketer, not tied to any assets that needs to be favored, can pick and choose suppliers and combine the output of many utilities to obtain the best combination of prices for customers. Moreover, by performing this service, customers can think of electricity as a commodity with the price defined by a single component--cost per kilowatt-hour.

Expansion of Power Marketers

In 1989, the Federal Energy Regulatory Commission certified the first power marketing company. Since then, the growth of the wholesale marketing business has been staggering: in 1994, nine firms resold 7.2 million megawatt-hours of electricity; a year later, 40 marketers sold 26.6 million megawatt-hours. Already, the business has its big players, with three companies--Enron Power Marketing, Lewis Dreyfus, and Electric Clearinghouse--making 57% of the sales.

The power marketers play an important role in an increasingly competitive utility industry. They help aggregate power from many sources, and they take advantage of price disparities among their suppliers to bring better prices to customers. They also enter various financial relationships between buyers and sellers that help reduce overall risk.

Spot Markets and Novel Trading Mechanisms

As electricity becomes more of a commodity, like natural gas, it can be bought and sold at wholesale spot markets at a few locations in the United States. At these sites--for example at a transmission interconnection point on the California-Oregon border--wholesale electricity contracts are bought and sold like any other commodity. To make the markets work properly, sufficient information about prices and availability are provided to purchasers and published in daily business newspapers.

Just like futures contracts for agricultural commodities are traded, so too are contracts on the future price and delivery of electricity. Starting in 1996, the New York Mercantile Exchange began selling contracts, and purchasing and sales options for power delivered at two spot market sites. These complex financial instruments may never be understood by most customers, but they allow power marketers and brokers to hedge against future price fluctuations of electricity, thus providing more stable prices over the long run. They constitute another element in an efficient competitive market for electricity.