How the power system works, and who makes money in it
Generation, grids and retail; the generation mix; the main market models by region; and the numbers the industry watches.
Industry brief, with a one-minute summary: Power and renewablesKey takeaways
- Electricity must be produced at the same moment it is used, because it is hard to store.
- Europe (liberalized market): generators compete to sell into a wholesale market every hour or quarter hour.
- India (state distribution companies): generators sell mostly to state-owned DISCOMs under long contracts, and central agencies run auctions for solar and wind.
- Capacity factor: the energy a plant actually produces in a year divided by what it would produce at full power all year.
- Levelized cost of electricity (LCOE): the average cost of each MWh over the plant's life, including the cost of building it.
Key idea
Electricity must be produced at the same moment it is used, because it is hard to store. The whole industry is built around this: power plants, grids and markets exist to match supply and demand every second.
Two units matter. Capacity is the maximum power a plant can produce at one moment, measured in megawatts (MW) or gigawatts (GW; 1 GW = 1,000 MW). Energy is power over time, measured in megawatt hours (MWh). A 100 MW plant running at full power for one hour produces 100 MWh. A home in Europe might use about 3 to 4 MWh a year; a large data centre can use as much as a small city.
- Power value chain
- GenerationMake electricity
- Thermal: gas, coal, oil (burn fuel)
- Nuclear
- Renewables: solar, wind, hydro, geothermal, biomass
- Storage: batteries, pumped hydro
- TransmissionHigh-voltage lines over long distances
- Run by a transmission operator, which also balances the system
- DistributionLow-voltage wires to homes and businesses
- Run by distribution companies (in India, DISCOMs)
- Retail and supplyBill the customer
- Tariffs, metering, collection, customer service
Generation competes in many countries. Transmission and distribution are natural monopolies (it makes no sense to build two grids), so they are regulated.
| Part | How it makes money | Main costs | What decides profit |
|---|---|---|---|
| Thermal generation (gas, coal) | Sells power per MWh, sometimes also paid for being available (capacity payments) | Fuel (often the largest), plant capex, maintenance, carbon cost in some regions | Spread between power price and fuel cost, and running hours |
| Solar and wind generation | Sells power per MWh, usually under a long contract (a power purchase agreement, PPA) | Almost all upfront capex and financing; no fuel | Capex, capacity factor, cost of capital, contract price |
| Transmission and distribution | Regulated return on the value of the network (the rate base) | Building and maintaining lines, substations, meters; losses | Allowed return, efficiency, and losses including theft |
| Retail | Margin between the tariff and the cost of buying power and using the network | Power purchase, network charges, billing, bad debt | Customer numbers, margin per MWh, collection rate |
So-what
Thermal plants are fuel businesses; solar and wind are financing businesses; grids are regulated businesses. The first driver differs for each.
The generation mix is the share of electricity made from each source. It differs a lot by region. Much of the Gulf relies on natural gas and is adding large solar plants. India relies mainly on coal but is adding solar and wind fast. Europe has a large share of wind, solar, nuclear and hydro. Many African countries rely on hydro, gas or diesel, and many people still have no grid connection at all.
Market models by region
- Europe (liberalized market): generators compete to sell into a wholesale market every hour or quarter hour. Plants are called on from cheapest to most expensive running cost (the merit order), and the last plant needed sets the price for all. Retailers compete for customers.
- Gulf (single buyer): a state-owned buyer signs long contracts with independent power producers (IPPs) through tenders, for example the Emirates Water and Electricity Company (EWEC) in Abu Dhabi and the Saudi Power Procurement Company. Contracts often run 25 years or more, so the key competition happens at the tender.
- India (state distribution companies): generators sell mostly to state-owned DISCOMs under long contracts, and central agencies run auctions for solar and wind. Many DISCOMs lose money because tariffs are below cost for some customers, and because of losses and unpaid bills.
- Africa (mixed): many countries have one state utility that generates, transmits and distributes, such as Eskom in South Africa. Others split the roles: in Kenya, KenGen generates much of the power and Kenya Power distributes and sells it. Governments add IPPs through tenders, and off-grid solar and mini-grids serve people the grid does not reach.
Key metrics, in plain words
- Capacity factor: the energy a plant actually produces in a year divided by what it would produce at full power all year. Solar is often around 15 to 30 percent, onshore wind 25 to 45 percent, a gas plant anywhere from 10 to 80 percent depending on how often it is called.
- Levelized cost of electricity (LCOE): the average cost of each MWh over the plant's life, including the cost of building it. It lets you compare solar with gas on one number.
- Heat rate: the fuel a thermal plant burns per MWh. A lower heat rate means a more efficient plant.
- Availability: the share of time a plant is ready to run.
- Technical and commercial losses: electricity lost in wires or never paid for (theft, unpaid bills). In India this is tracked as AT&C losses (aggregate technical and commercial losses).
- Peak demand: the highest demand in the year, which sets how much capacity the system needs.
- Curtailment: renewable power that is available but switched off because the grid cannot take it.
A 50 MW wind farm in South Africa produced 131,400 MWh last year. What was its capacity factor, as a decimal? (A year has 8,760 hours.)
Why are transmission and distribution grids usually regulated rather than left to competition?
Sources for this lesson (2)
- Recognized public explanations of case-interview concepts and frameworks
- IRENA, Renewable Power Generation Costs in 2024
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