Congestion Pricing: Competitive Locational Prices of Power Stoft (2002)

Congestion Pricing Summary 5-3: If there are binding physical transmission limits between locations, a competitive bilateral market with physical transmission rights will trade power at different prices in different locations. – Called competitive locational prices of power (CLPs) 5-4: Central computation finds the optimal dispatch then computes prices from the marginal benefits of a free megawatt at each location. Bilateral traders never consider the optimal dispatch but look only for profitable trades. These two different processes lead to the same quantities being traded and to the same prices because perfectly competitive bilateral trade is efficient.

Congestion Pricing Is Competitive Pricing Transmission lines have capacity limits which must be enforced in order to protect the lines and the stability of the system. When traders would like to use more capacity than is safely available, transmission is a scarce resource. The slides that immediately follow will analyze a single transmission line whose transmission rights are allocated by a competitive market. – Provide a useful benchmark to compare the price outcomes of proposed market architectures to. – Provide an example of bilateral trading – often considered the opposite of centralized nodal pricing. However, both systems aim for the same set of prices.

Competitive Market Structure Two trading locations – Bus 1 – rural area – 100 MW of power needed – Bus 2 – city (the load center) – 800 MW of power needed Connecting transmission line can handle 500 MW. Thus, only 500 MW of transmission rights are issued. – The rights confer on their owner the right to transmit power from Bus 1 to Bus 2 – Initial owner of rights is unimportant – Rights need to be tradeable – Owner of rights cannot exercise market power

Bus 2 – needs 800 MW of power Bus 2 has 500 MW of generation and the 500 MW transmission line connecting it to Bus 1 (where generation capabilities are > 500 MW) Large number of small generators are located at each bus Cost of generation – Bus 2 – starts at $40/MWh and increases at the rate of $2/MWh for each additional 100 MW of output (summarized supply curve: 40 + Q/50 ) – Bus 1 – start at $20/MWh and $2/MWh for each additional 100 MW (supply curve: 20 + Q/50 )

The Price of Transmission Rights Traded separately from energy Either buyer or seller must own a transmission right in the amount of power sold Competitive pressures in the bilateral market will drive the price of transmission rights to the energy price difference between Bus 1 and Bus 2 – i.e. P AB = P B - P A

Congestion Defined In a competitive market, the path from A to B is congested if the price of transmission rights from A to B is positive. This is equivalent to the price of power at B being greater than the price of power at A. If a line would be overused if its limit were not enforced, it is congested.

The Price of Power Both the rural area (Bus 1) and city (Bus 2) customers would buy their power at Bus 1 if there were no transmission limits. Thus, the line is congested. Only 500 MW can be transported from Bus 1 to 2. To meet Bus 2’s total demand of 800 MW, 300 MW will be generated locally. Price of power obtained from supply curves: Price of power at Bus 1: ( /50) = $46 MWh Price of power at Bus 2: ( /50) = $32 MWh

Price of Transmission Remember: P AB = P B – P A $14 = (46-32)

Benefits of Competitive Locational Prices Normal competitive prices – Have standard properties promised by economics for competitive prices Suppliers will minimize cost of production Prices equal marginal values to consumers (i.e. consumers only use an additional megawatt of power when they value it more than its cost of production)

Centralized Computation of CLPs When CLPs are calculated by a central authority, such as an ISO Provided generators and customers tell ISO their true supply and demand curves, the ISO will find the same CLPs that a bilateral market would

Central Computation Details No transmission rights, only an energy market Each generator and every load customer submits a bid to the ISO which specifies the location that they will provide or take power. – Generators typically bid a supply curve, that is they are willing to provide larger quantities at progressively higher prices – Load customers bid similar demand curves The ISO maximizes total surplus and sets price equal to marginal surplus at every location, essentially clearing the market.

Centralized Computation Example

Bilateral Pricing Compared to Centralized Pricing Centralized computation tries to minimize total cost of production. Bilateral traders try to maximize own profits If no profitable bilateral trades can be found then centralized pricing has returned the bilateral outcome

Trades from Centralized Example Trade #MWFromToSale PriceTRs 1150AB$45100 MW 2300AA$ BB$ A & BC$400

Problems/Solutions Centralized computation is accused of calculating too many prices – Either a bilateral or centralized market can be set up to find fewer but less accurate prices – Increases “gaming opportunities” If there are small enough competitors (low market power), both a bilateral market and centralized computation will be competitive – Whether either is more susceptible to market power remains an open question