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3-2
3-3 3-4
3-5
3-6
3-7
3-8
Chapter
3-1
ARKET ARCHITECTURE CONCERNS THE KEY DESIGN ELEMENTS. While Part 2 abstracts from all questions of market design to
focus on market structure, Part 3 considers alternative designs for the realtime market, the day-ahead forward markets and the relationship between the two. It also discusses several controversies, such as the degree of centralization, that have often plagued the design process. Design elements are considered in just enough detail to allow comparisons between the main alternative approaches. While Part 3 moves forward from real-time it does not move past the dayahead market, and it does not consider private bilateral markets that operate beside the markets organized by the system operator (SO). It focuses only on those markets that are typically part of an ISO design. Section 1: Spot Markets, Forward Markets and Settlements. Forward markets are financial markets while the realtime (spot) market is a physical market. To the extent power sold in the day-ahead market is not provided by the seller, the seller can buy replacement power in the spot market. This is the basis of the two-settlement system that underlies one standard market design in which the SO conducts both day-ahead and spot energy markets. Section 2: Controversies. Three major controversies have beset the design of power markets. First is the conflict over how decentralized the market should be. One view holds that both day-ahead and spot markets should be bilateral energy markets, and the SO should have no dealings that involve the price of energy but instead sell (or ration) only transmission. The second conflict arises only if the day-ahead market is to be run by the system operator (centralized). One view holds that such an auction market should utilize multi-part bids to solve the unit commitment problem in the
traditional way. Another view holds that bids should specify only an energy price. The third conflict concerns the level of detail at which locational prices are computed. The nodal view typically argues for hundreds or thousands of locations, while the zonal view typically calls for well under one hundred. This controversy is less fundamental and is not considered in Part 3. Section 3: Simplified Locational Pricing. All markets discussed in Part 3 produce energy prices that are locationally differentiated. The theory of such prices is not presented until Part 5, so a summary of their properties is given in Section 3. These prices are competitive and thus independent of the markets architecture. Because they are competitive they have the normal properties of competitive prices; they minimize production cost for a given level of consumption, and they maximize net benefit.
3-1.2 CONTROVERSIES
Three main controversies regarding architecture have beset the design of many power markets. 1 2 3 Central vs. bilateral markets Exchanges vs. pools Nodal vs. zonal pricing
The first two controversies both concern the amount of centralization. In theory all power trades could be handled by bilateral markets in which private traders trade directly with each other, or through a middleman (power marketer), but not with an exchange or pool. This approach is particularly cumbersome for balancing the system in real time. Once it is admitted that centralization is needed, an attenuated form of the same controversy questions the extent to which the system operator should provide coordination. Should it collect large amounts of data on generators and compute an optimal dispatch, or should it let generators signal these parameters indirectly through the energy prices they bid? Last, there is a controversy over how finely the system operator should compute locational energy prices. A nodal pricing approach would define more than a thousand distinct locations in California. When the market was first designed the advocates of zonal pricing suggested that two zones would be sufficient, though many more were added later around the edge. More were subsequently required in the interior. This is the least fundamental of the three controversies and is not discussed in Part 3. Central vs. bilateral markets. The first two controversies concern the role of the system operator (SO). Some wish to minimize its role at almost any cost. Chapter 3-2 takes up the question of whether completely bilateral markets are possible and concludes that the system operator must perform a centralized allocation of transmission rights, but with the use of sufficient penalties and
curtailments the SO could be kept from making any trades. Of course, its influence on the market would still be pervasive. Chapter 3-3 considers the possibility of a centralized spot market in transmission only. This would allow private bilateral markets to provide the spot energy market, but because this arrangement makes the realtime balancing of the system difficult and expensive, it is rejected in favor of an energy spot market (realtime balancing market) run by the SO. Chapter 3-5 considers the same question for the DA market, but in this case the answer is less obvious as the time pressure is far less severe. Here the answer hinges on the unit commitment problem and the need for coordination. Although a private bilateral market would cause much less inefficiency, there appears to be a strong case for at least the minimal central coordination that can be provided by a pure-energy market run by the system operator. Exchanges vs. Pools. Unit commitment is the process of deciding which plants should operate. Integrated utilities have always done this using a centralized process that takes account of a great deal of information about all available generation. If this is done incorrectly the wrong set of plants may be started in advance which can lead to two problems: (1) inefficiency and (2) reduced reliability. As just noted, a bilateral market solves this problem poorly, so a centralized DA market is preferred. The second controversy concerns the extent of central coordination. There are two polar positions: let generators bid only energy prices (1-part bidding) or let generators bid all of their costs and limitations (multi-part bidding). One-part bidding allows the SO to select the amount of generation to commit in advance but gives it very little information about the generators costs and limitations. Consequently it can apply none of the usual optimization procedures, but it can provide some coordination by purchasing the correct quantity of power a day ahead. With multi-part bids, the SO can select bids on the basis of the traditional optimization procedure. Typically, this controversy focuses on comparing the existence, efficiency and reliability of the market equilibria for 1-part and multi-part auctions. Chapter 3-7 demonstrates that both types of markets have equilibria that exist and that are likely to be very efficient and reliable. If there is a problem, it is that markets have difficulty in arriving at the equilibrium of a 1-part auction market when costs are non-convex as they are in power markets. This difficulty arises from the extensive information requirements of 1-part bidding. In such an auction, competitive suppliers should not simply bid their marginal costs but must estimate the market price in advance in order to determine how to bid. This is a far more difficult task than simply bidding ones own costs as required by normal competitive markets or by a multi-part bid auction. Unfortunately, not enough is known about how such markets perform in practice so no conclusion can be drawn as to which is preferable, though it seems plausible that a two or three part auction could be designed to capture
This relationship is all that is needed to understand Part 3, but it contains one surprise that deserves attention. Because transmission prices are not based on a cost of transporting the power (we ignore the cost of losses which is minor) but are based instead on the scarcity of transmission (line limits), transmission costs can be negative. In fact, if the cost of transmission from X to Y is positive, then the cost from Y to X is certain to be negative. This is a direct result of the above formula. This peculiarity can be understood by noting that when power flows from Y to X it exactly cancels (without a trace) an equal amount of power flowing from X to Y, thus making it possible to send that much more power from X to Y. A second consequence of the above formula is that the cost of transmitting power from X to Y does not depend on the path chosen All of the markets discussed in Part 3 are assumed to compute locational prices and to operate competitively. Consequently, they will produce the locational energy prices and transmission prices just described. In spite of their ubiquitous presence, the reader will not need to understand details of how locational prices are computed and nor rely on either of the properties just discussed. They are presented merely to provide context.
Chapter
3-2
HE MIN-ISO APPROACH TO POWER MARKET DESIGN, POSTULATES THAT THE LESS COORDINATION THE BETTER THE MARKET.1 This philosophy underlies attempts to keep the system operator out
of the energy market. In other markets this would be possible. For example the U.S. Department of Transportation does not buy or sell trucking services, it just provides highways and charges for their use. This chapter examines the inefficiencies that would result from keeping the system operator out of the real-time energy market. Section 1: No Central Coordination. Imagine an electricity market run as a system of highways. Every power injection by a generator could be measured and charged to pay for the cost of the system. Any generator could sell power to any customer and deliver that power by injecting it at the same time the customer used it. Unfortunately, there would be no way to prevent theft. With trading fully decentralized, no one would know who had paid and who had not. Section 2: Central Coordination without Price. The simplest actual proposal for a power market suggests that all trades be registered with the system operator who would accept only sets of trades that did not cause any reliability problem. This proposal takes the first step towards the enforcement of reliability and the prevention of power theft, but it does not take the second step of specifying what happens when traders violate their schedules. In this system the operator knows nothing of prices, and imposes no penalties.
Although, it does recognize the need to enforce transmission constraints it proposes to do this with arbitrary curtailments and without the use of any market mechanism..
Section 3: A Pure Transmission Market. The next step is to sell transmission rights. This improves on the previous system by removing the arbitrariness from the distribution of transmission rights and reduces the transaction costs by centralizing the transmission market. It does not solve the problem of balancing the real-time market. This could be accomplished with penalties and curtailments. These would induce the development of private system operators. Because system operation is a natural monopoly it would be necessary to limit their size. Although this could produce a workable power market it would have much higher transactions costs than necessary.
Chapter
3-3
ORWARD MARKETS SELL PROMISES OF POWER, THE SPOT MARKET SELLS ELECTRICITY. But the system operator need not be
allowed to trade electricity and instead could sell transmission to bilateral traders of electricity. Although there is nothing inherently wrong with this process, it is slower than centralized energy trading. When balancing the power system, time is of the essence. In fact the price mechanism is orders of magnitude too slow to do the complete job. So to get the maximum benefit from markets, the fastest market must be used for balancing, and that is a centralized locational energy market. Section 1: A Pure Spot-Market For Energy. Every deviation from balance is handled by a sequence of procedures the first of which take place in less than a tenth of a second. Because great speed is required, the initial process, to the extent it is not automatic must be centrally directed. Current pricing mechanisms are not much use in time frames under ten minutes. But at some point, the job of equating supply and demand can be handed over to a market mechanism. This is the real-time or balancing market. System balance for a control area is determined by a combination of net inflow and system frequency. Even if every bilateral trade using a particular control area is in perfect balance, the system operator will be directed to either increase or decrease generation if the system frequency is off, which it almost always is. Consequently the operator must have some control over energy. Section 2: Conclusions about the Real-Time Market. The essence of the problem of system balancing is speed. Once the most time-critical part of balancing has been handled their comes a point where price can do the job. But
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in order to maximize the usefulness of the market, the fastest market should be used, and that is a centralized energy market. A transmission market can only sell transmission when two equal but opposite energy trades have been found. Thus a transmission market is just an energy market with restrictions, and it is inherently more expensive when great speed is needed. Of course by spending more on market infrastructure any market can be made faster. The usual proposal is to impose penalties on bilateral trades that get out of balance. This appears to keep them in balance cheaply, or even at a profit. (To stay in balance they must adjust very quickly, so this is method of speeding up the market.) But penalties simply hide the costs, which must be born by those with bilateral contracts. It is wiser to use a locational energy market as the real-time market and leave bilateral trading to forward markets that can proceed at a more leisurely pace.
Chapter
3-4
USTOMERS AND GENERATORS SHOULD RESPOND TO THE SPOT PRICE AS IF THEY HAD BOUGHT AND SOLD ALL THEIR POWER IN THE
Typically, however, they buy and sell almost all of their power in forward markets. Fortunately, the correct settlement system insulates the real-time markets and preserves their incentives. Contracts for differences (CFDs) insulate forward contracts from the realtime (spot) price even though loads and generators trade all of the power in their spot market after having already traded it in the forward markets. From a traders point of view, the main problem with spot markets is timing of transmission costs. These are not posted in advance but are determined along with the price of energy in the spot market. This is often called ex-post pricing. Although determining the real-time price is simple in theory (just set price so supply equals demand), it is complex in practice. Most real time markets have a large number of rules, and there is little consistency in these rules between systems. Their purposes vary. Some are designed to limit market power, some to protect the system from sudden shifts in supply and demand that might result from or cause price instability. Others are the result of software anomalies or various superstitions, but this chapter will ignore such complexities and stick to basics. Section 1: The Two-Settlement System. If the system operator runs a dayahead (DA) and a real-time (RT) market, generators should be paid for power sold in the DA market at the DA price regardless of whether or not they produce the power. In addition, any real-time deviation from the quantity sold a day ahead should be paid for at the real-time price. This system allows an
SPOT MARKET.
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almost complete separation between the markets. Even if a generator sells essentially all of its power in the day-ahead market, it will still have the correct incentive to deviate from that contract in response to realtime prices. In real time the generator has the same incentives as if it were selling all of its power in real time. Loads are treated analogously with the same effect. If bilateral traders use contracts for differences (CFDs), and if the spot price does not vary with location, bilateral trades will be unaffected by the spot price even though the generators and loads sell all of their power in the spot market, provided they generate according to their contract. In spite of this, CFDs leave them with the proper incentive to deviate in ways that benefit the deviating party and leave the other parties unaffected. Section 2: Ex-Post Prices: The Traders Complaint. Spot prices that differ by location impose transmission costs on traders. These cannot be avoided by the use of CFDs, and they make trade risky. Time-of-use transmission charges could be posted in advance as an approximation of congestion charges, but their inaccuracy would cause an inefficient dispatch. A reservation system would be required to avoid the most serious inefficiencies. A market in transmission rights would be preferable to reservations sold at regulated prices. Such markets exist, but are limited and illiquid. Technical and practical difficulties have prevented the development of more robust markets, but these problems are receiving considerable attention. Transmission rights can be financial or physical, and financial rights can be used effectively as a reservation to assure complete protection from realtime transmission charges. Section 3: Setting the Real-Time Price. The real-time price should be set to clear the market. As not all response to price changes is reflected by supply and demand bids, if price is set strictly on the basis of these bids, it will overshoot. This problem will grow as real-time pricing becomes more prevalent, which will make it necessary for the system operator to improve its understanding of the dynamic affects of price changes.
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Result 3-4.1
A Two-Settlement System Preserves Real-Time Incentives When the real-time market is settled by pricing deviations from forward contracts at the real-time price, supplier and customers both have the same performance incentives in real time as if they traded all of their power in the real-time market.
The incentive of this settlement rule can be revealed by rearranging the terms as follows: Supplier paid: Q1(P1 P0) + Q0 P0 When real-time arrives, Q1 has been determined in the day-ahead (DA) market. Assuming the market is competitive, the generator has no control over either price, and by real time the first term will be taken as given. The first term will be viewed as a sunk cost or an assured revenue. This leaves the second term
Chapter
3-5
OWER MARKETS ARE DIFFICULT TO COORDINATE BECAUSE THEY DO NOT SATISFY THE ASSUMPTIONS OF A CLASSICALLY COMPETITIVE MARKET. Under classical assumptions, suppliers need to
know only their own costs, and no central coordinator is needed. For a power market to perform efficiently, either it must be centrally coordinated or suppliers must know a great deal about the market equilibrium price in advance. The root of the problem is generation costs that fail to satisfy a key economic assumption used to prove the efficiency of competitive markets.6 Because the proof of efficiency fails, uncoordinated power markets are often believed to have no equilibrium or only a very inefficient one. In fact they have equilibria that are extremely efficient but difficult to discover. This chapter argues that at least a small amount of central coordination is well worth while and should take the form of a centralized day-ahead market. The question of whether this market should perform a full centralized unit commitment is discussed in Chapter 3-7. In a classic competitive market, suppliers can offer to supply (in a bilateral market) or to bid (in an auction market) according to their marginal cost curve. When all do so, the market discovers a perfectly efficient competitive equilibrium. But with non-convex costs of generation, it becomes necessary for generators to bid in a more complex manner.
Part 2 focused on the consequences of the far more serious demand-side flaws in contemporary power markets. Part 3 ignores these and focuses on problems with generation costs that are very small but unavoidable.
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One market design allows suppliers to continue bidding their marginal costs but include other costs and limitations in their multi-part bids. This has the advantage of allowing suppliers to base their bids on easily obtained information: their own costs. Another approach can take the form of a decentralized bilateral market or a centralized market with one-part energy bids. In both cases, suppliers must account for all of their costs and limitations in their energy price bid so they do not bid their true marginal costs.7 With this approach, suppliers must utilized considerable information about the external market. This chapter argues that the second approach, with its formidable information requirements, causes coordination problems that are more severe in bilateral markets than in a centralized one-part-bid energy auction. It concludes that the coordination problems in a bilateral market will be substantial enough that this approach should not be adopted for the day-ahead market. If bilateral markets promised some important advantage, their reduction of efficiency and reliability might be justified. But bilateral markets have higher transaction costs and are less transparent than a public auction. They are also impossible to use for settling futures contracts. Finally, adopting a centralized day-ahead market does not preclude the operation of a bilateral day-ahead market. Section 1: When Marginal-Cost Bidding Fails. A cost function is nonconvex if costs increase less than proportionally with output. Startup costs, no-load costs, and several other components of generation costs contribute to making them non-convex. Consequently generation costs fail to satisfy the conditions necessary to guarantee a competitive equilibrium. This does not necessarily prevent the market from being very efficient, but will cause competitive suppliers to bid above marginal cost if they cannot bid their startup and no-load costs directly. The amount they should bid above marginal costs depends on the outcome of the market which can only be estimated at the time of bidding. Section 2: Reliability and Unit Commitment. In a bilateral market, generators must commit (start running) without knowing which other
Day-ahead bilateral markets could allow very complex contracts but do not because it would make contracting too expensive.
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Chapter
3-6
HERE ARE MANY POSSIBLE DESIGNS FOR A CENTRAL DAY-AHEAD MARKET, BUT ALL CAN BE DESCRIBED AS AUCTIONS. The most
obvious design just prices energy like the real-time market. A different approach turns the system operator (SO) into a transportation service provider who knows nothing about the price of energy but instead sells point-to-point transmission services to energy traders. Either of these approaches presents generators with a difficult question. Some generators must engage in a costly startup (commitment) process in order to produce at all. Consequently, when offering to sell power a day in advance, a generator needs to know if it will sell enough power at a price high enough to make commitment worthwhile. Some day-ahead (DA) auctions require complex bids that describe the generators startup costs and other costs and constraints and solve this problem for the generators. If the SO determines that a unit should commit, it insures all its cost will be covered provided the unit does commit and produces according to the accepted bid. Such insurance payments are called side payments, and their effect on long-run investment decisions is considered in Section 3-7.3. The three approaches just named, energy, transmission and unit commitment can also be combined into a single auction that allows all three forms of bid; this is how PJMs day-ahead market works. Generators can offer complex bids and receive startup-cost insurance if they are selected to run. Anyone can offer to buy or sell energy with simple energy bids, and traders can request to buy transmission from point X to point Y without mentioning a price for energy. PJM considers all of these bids simultaneously and clears the
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market at a set of locational energy prices together with startup-cost insurance. The differences in energy prices from location to location determine the prices for transmission. Section 1: Defining Day-Ahead Auctions. All day-ahead markets organized by system operators are auctions. Market participants submit bids, and the auctioneer (the SO) arranges trades according to a simple principle: maximize the net benefit as defined by the bids. If a customer offers to pay $40 and manages to buy for $30, the net benefit is $10. The calculation for suppliers is similar. The auction accepts the set of bids that maximize the sum of these net benefits and sets prices so that all trades are voluntary. The four day-ahead markets discussed here follow these simple principles and differ only in the type of bids they allow. Some allow bids for energy, some for transmission, and some allow complex bids that specify many costs and limitations for each generator. Section 2: Four Day-Ahead Market Designs. Each auction is specified by three sets of conditions: bidding, determining which bids are accepted, and determining the payments associated with the accepted bids. Market 1, a pure energy market, determines nodal prices. Market 2, trades only transmission and involves no prices for energy. Market 3 adds unit commitment to Market 1. Market 4 combines the features of the other three and is modeled on the current PJM market. Section 3: Overview of the Day-Ahead Design Controversy. Forward markets are bilateral and realtime markets are centralized. The day-ahead market can be designed either way and this causes a great deal of controversy. The nodal pricing approach specifies an energy market with potentially different prices at every node (bus), and, almost always, specifies that the auction should solve the unit commitment problem as well. This requires a great increase in complexity of bids. The bilateral approach specifies that energy trades take place between two private parties and not between the exchange and individual private parties. To trade energy, the private parties require the use of the transmission system, so the system operator is asked to sell transmission. Market 2, takes a purely bilateral approach, while market 3, takes the full nodal pricing approach. Market 1, the simplest market, implements nodal pricing, but not unit commitment. Market 4, the most complex, implements all the features from both the bilateral approach and the nodal pricing approach.
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Determining Quantities
Auctions must determine the quantities sold and purchased and the price. Although the two are closely related they are separate problems, and the same set of bids can yield the same quantities but different prices under different auction rules. From an economic perspective, it is quantities that determine efficiency, and prices are important mainly to help induce the right trades.
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In all four auctions described here, quantities of accepted bids are selected to maximize total net benefit. This assumes the bids reflect the bidders true costs and benefits. Although they may not, assuming that they do generally encourages truthful bidding. Total net benefit is the sum of customer and supplier net benefit, but it is also the benefit to customers minus the cost to suppliers. This simplification helps explain the role of price as well as the economists attitude towards price, as an example will make clear. If a customer bids 100 MWh at up to $5,000/MWh, and the bid is accepted, the benefit to the customer is $500,000. If the market price is $50/MWh, the customers cost is $5,000 and net benefit is $495,000. Similarly, if a generator bids 100 MW at $20/MWh, its cost is presumed to be $2000. If the market price is again $50/MWh, its net benefit will be 100x($50$20), or $3000. Writing this calculation more generally reveals that the price played no role in determining total net benefit. Total Net Benefit = Qx(VP) + Qx(PC) = Qx(VC), where Q is the quantity traded, V the customers value, C the suppliers production cost, and P is the market price. Thus the problem of maximizing net benefit can be solved independently of any price determination. In an unconstrained system, net benefit can be maximized by turning the demand bids into a demand curve and the supply bids into a supply curve and finding the point of intersection. This gives both the market price and a complete list of the accepted supply and demand bids. Unfortunately transmission constraints and constraints on generator output (e.g. ramp-rate limits) can make this selection of bids infeasible. In this case it is necessary to try other selections until a set of bids is found that maximizes net benefit and is feasible. This arduous process is handled by advanced mathematics and quick computers, but all that matters is finding the set of bids that maximizes net benefit, and they can almost always be found.
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of $220. Consequently it causes no problem to say that the market price equals both the marginal cost of supply and the marginal value of demand. [fig] Consider how net benefit changes when an extra kW is added to the total supply of power at zero cost. This will shift the supply curve to the right and will have one of two consequences. Assuming that both curves are step functions, it will either increase the amount consumed by 1 kW, or not increase it at all. If consumption is increased, the benefit of that consumption will be the market price, and the cost of supply (the added kWh) will be zero. The net benefit per kW is the market price. If consumption is not increased, some supply with a cost equal to the market price will be displaced by the new zerocost kWh. This leaves benefit unchanged and reduces cost, so again the net benefit per kW is the market price. If the supply and demand curves were smooth, the result would have been the same except there would have been a contribution from both increasing benefit and decreasing cost. Similarly the reduction in net benefit from extracting a kW from the system is also given by the market price. Thus, no matter how you compute it, the marginal value of power to the system sets the market price. Contrary to popular belief, auctions are not designed to determine who sells and who buys by comparing bids to the price determined by marginal-cost. Marginal cost pricing is not a goal, it is a byproduct. Auctions determine which set of trades is the most valuable possible (feasible) set of trades, and selects this set. Once they have been selected, the market price at each location is set to the marginal value or marginal cost of supply to the system at that location.12 The market price, MP, determined in this way has two properties. First, at every location, the MP falls on the dividing line between bids that are accepted and those that are not. If some bids are partially accepted then MP is equal to their price. Second, given the first property, the difference between the total
12
The net benefit should be in $/h.. A kW, rather than a MW, is used to indicate that only a marginal change is being made. Technically one should use calculus, but this is of no practical significance.
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amount paid by customers and the amount paid to suppliers is as small as possible. No other price would have these two properties.
Market 2: Transmission
The transmission auction is equally simple for the system operator but requires a complex pre-market step for market participants. Buyers and sellers must find each other and make provisional energy trades that depend on whether or
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Notation used in auction market descriptions PS(Q), and PD(Q) QD QA MPX, MPXY MP0, Q0 X, Y Cstart Cost Benefit {} Supply offer curve and demand bid curve Quantity demanded ( used in place of PD(Q) ) Quantity accepted (supply or demand) Locational market price in DA auction for energy or transmission. Price and quantity of a specific participant in the real-time market. Two different locations. Startup cost. Variable production cost. Sum of area under all PS(Q), 0 ! Q ! QA Consumer benefit. Sum of area under all PD(Q), 0 ! Q ! QA a set of prices or quantities
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Non-decreasing PS(Q) Non-increasing PD(Q) or QD Different supply and demand bids allowed for each hour. {MPX} and {QA} for each hour. Maximize total NB = (Benefit Cost). MPX = Net Benefit, NB, of a costless kWh injected at X. MPX >= PS(QA) MPX <= PD(QA), or QA = QD MPX can be different at each location, X, but must be the same for all accepted bids and offers at each X. Transmission flow limits. Pay: Charge: Both: QA x MP + (Q0 QA ) x MP0 QA x MP + (Q0 QA ) x MP0 Q0 is the quantity actually produced or consumed. MP0 is the real-time price.
Format (for both): Acceptance Problem: Restrictions (supply): Restrictions (demand): Restriction on MP: Constraints:
Settlement Rules:
Supply: Demand:
Comments:
Because generators cannot bid their startup costs, it is generally believed they need to submit different price bids in different hours. Loads, whose usage is largely unrelated to price, must do the same. {QA} represents the set of accepted bid quantities, one for each supplier and each demander; a different one in every hour. To determine which bids are accepted, the auction first finds the set of supply and demand bids which, if accepted, would maximize total net benefits, NB, to all market participants. Then market price at each location is determined by asking how much NB would be increased by making another kWh available at no cost at that location. After introducing the free kWh, the optimal accepted bids are again determined, and this determines a slightly higher NB. That is the value of the kWh and that value sets the price per kWh at that location. The increase in value can come from either more consumption or less production cost. A kWh is specified to mimic a marginal change which is normally computed by taking a derivative. A day-ahead market is a forward market, and the forward price holds if suppliers deliver and customers take delivery of the DA quantity. Participants know they sometime cannot make or take delivery exactly, so strategy in the day-ahead auction will depend on what happens in the real-time market. New York, for instance, imposes a penalty of exactly (Q0 QA ) x MP0 on generators, completely cancelling real-time payments for extra production. This is perhaps the greatest penalty in any current ISO market. [box]]
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Format:
Bid Acceptance Rules:
{PT, Qmax > 0, from X to Y} for each hour. {MPXY}, {QA <= Qmax} for each hour. Maximize total NB = sum PT x QA. MPX = Net Benefit, NB, of a 1 kW increase in the transmission limit form Y to X. MPXY <= PT of accepted bid. MPXY is the same for all accepted bids from X to Y. Transmission flow limits. QA x MP + (Q0 QA ) x MP0 Charge: Where Q0 is the quantity actually transmitted from X to Y, and MP0 is the real-time price from X to Y.
Comments:
Note that PT and MPXY are prices for transmission, not energy. Even if every MPXY is known, it is not possible to compute energy prices from transmission prices. If there are 10 locations there will be 90 pairs of locations and consequently 90 transmission prices. But MPXY = MPYX. Also, MPXY + MPYZ = MPXZ. All of these prices can be determined from 10 locational energy prices. Adding the same constant to these ten prices does not change their differences and so leaves the transmission prices the same. The apparent complexity of transmission prices masks an underlying simplicity of energy prices. The net benefit of the transmission sold in the auction is the sum of the accepted quantities times the price bid. This gives the value placed on the transactions by the bidders. The extra value added by expanding the transmission capacity from X to Y by 1 kW for an hour is called the shadow price of the line form X to Y. Setting MPXY equal to this price makes it satisfy the two restrictions on MPXY. In addition, this price minimizes the charges for transmission given these restrictions and gives competitive bidders an incentive to bid their true values. Allowing fixed-quantity bids creates difficulties, so it is probably best not to allow them. Any rights that are purchased and not used are most likely still valuable as can be seen from the settlement rules. If Q0 = 0, i.e. none of the rights are used, then the purchaser receives a payment of QA x MP0 from the real-time market. This may be more or less than the cost of the rights, QA x MP, but on average arbitrage should keep these nearly equal. box]
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Non-decreasing PS(Q) / Cstart / ramp-rate limit / etc. Only one supply bid is allowed per day. Non-increasing PD(Q) or QD, one bid per hour. Commitment: Yes / No {MPX} and {QA} for each hour. Maximize total NB = (Benefit Cost). MPX = Net Benefit, NB, of a costless kWh injected at X. MPX is computed with the selected units committed. Transmission security, ramp-rate limits, etc. Pay: Provide: Charge: R = QA x MP + (Q0 QA ) x MP0 Startup insurance if: Commitment = Yes QA x MP + (Q0 QA ) x MP0 + uplift
Startup insurance is provided to generators who are scheduled to startup by PJM in the DA market and who do startup and follow PJMs dispatch. Following dispatch amounts to starting up when directed to and keeping output, Q, within 10% of the value that would make PS(Q) equal the real-time price. Startup insurance pays for the difference between as-bid costs and market revenues, R. As-bid costs include at least energy costs, startup costs and no-load costs. Most generators that startup do not receive insurance payments as they make enough short-run profits. The total cost of this insurance is less than 1% of the cost of wholesale power. Uplift includes the cost of startup insurance and several other charges. [box]
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Non-decreasing PS(Q) / Cstart / ramp-rate limit / etc. Only one supply bid is allowed per day. Non-increasing PD(Q) or QD. {PT, Qmax > 0, from X to Y} for each hour. Buy Q at up to PE. Sell Q at PE or higher. Commitment: Yes / No {MPX} and {QA} for each hour. Maximize total NB = (Benefit Cost) MPX = Net Benefit, NB, of a costless kWh injected at X. Transmission security, ramp-rate limits, etc. Pay: Provide: Charge: R = QA x MP + (Q0 QA ) x MP0 Startup insurance if: Commitment = Yes QA x MP + (Q0 QA ) x MP0 + uplift
* This description is still simplified as it leaves out PJMs daily capacity market, various other markets, and near-markets for ancillary services and all of the accompanying uplift charges. However this formulation captures the central characteristics of a flexible market containing the described Pool which uses complex bids. The acceptance problem solved by PJM differs from the one in Market 4 in that only cost-savings from generation counts towards net benefit. In other words, a demand bid can not set the price, only a supply bid can. Ramp-rate limit is meant as a proxy for this and various other constraints on the operation of generators, such as minimum down time. Startup cost, Cstart, is also meant as a proxy for other costs that are not captured in the supply function PS(Q), such as no-load cost. [box]
Chapter
3-7
Y ALLOWING ONLY 1-PART ENERGY BIDS, A DAY-AHEAD AUCTION CAN FORCE SUPPLIERS TO SOLVE MUCH OF THE UNIT COMMITMENT PROBLEM INDIVIDUALLY. The extreme alternative is to
allow multi-part bids so generators can specify, start-up costs, no-load costs, ramp-rate limits and many other costs and parameters, then have a system operator make the traditional calculation. Traditionally, utilities have used a great deal of information about each generator and in recent years have performed sophisticated calculations to decide which units to commit. Some power markets, such as those in California, Alberta and Australia, abandon this approach with little apparent degradation of the dispatch.14 Chapter 3-5 considered whether the unit-commitment problem should be solved with the aid of a centralized auction market or a decentralized bilateral market and concluded that the auction market is preferable. Chapter 3-6 described four auction designs two of which will be analyzed in this chapter. Market design #1, a pure energy market allows generators only 1-part bids that specify a price of energy which depends on their level of output, and market design #3, a unit-commitment (UC) market allows generators to specify a long list of parameters describing their costs and physical limits. Utilities use huge quantities of data, sophisticated software, and advanced mathematics to determine which units to commit in advance and how long to keep them committed. In a pure-energy auction, all of this is replaced by a
14
Quite possibly, these systems still rely on much of the data that is no longer collected but which operators are well aware of; this would include ramp rates.
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simple rule that says, use the cheapest power first.15 That this works at all is testimony to the coordinating powers of a market, but there are a number of unanswered questions. This chapter investigates how a market performs this coordination and what problems it may encounter. Section 1: How Big is the Unit Commitment Problem? Startup costs are one of the more significant costs contributing to the unit commitment problem. Typically, these amount to less than 1% of retail costs. More than half of these are covered by normal marginal cost pricing. If the inefficiency caused by the remaining startup costs were as high as 50%, the total loss from poor unitcommitment would be less than 1/4% of total electricity costs. Quite plausibly, actual inefficiencies caused by even the pure-energy auction may be an order of magnitude smaller. Fixed cost must be covered by marginal cost pricing and they are much greater than startup costs. As they are taken out of infra-marginal rents before fixed costs, startup costs usually are covered by energy revenues except in the case of generators that provide only reserves. Section 2: Market Design #1, A Pure Energy Auction. Sometimes an efficient dispatch and marginal-cost pricing do not cover startup costs. Example 2 considers this situation from four perspectives. Case A demonstrates that there is no competitive equilibrium in the classic sense. Case B demonstrates that an auction without startup-cost bids or side payments can have an efficient competitive Nash equilibrium in spite of lacking a classic competitive equilibrium. Case C considers a 1-part, pure-energy auction. This produces an inefficient but competitive equilibrium. Case D includes the possibility of de-commitment, i.e. failing to generate the power sold in the dayahead market. This possibility leads to greater over-commitment in the dayahead market and then de-commits to the point of an efficient dispatch. Section 3: Design #3, a Unit-Commitment Market. A unit-commitment market insures generators dispatched in the day-ahead market against failing to cover their startup costs. If all generators bid honestly, and the dispatch is always efficient, these insurance payments will interfere with long-run efficiency by providing inappropriately large investment incentives to generators with especially large startup costs. Because insurance payments are
15
This chapter ignores the transmission congestion problem in order to focus on the classic unit-commitment problem which assumes a unified market.
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Conclusion
If generators cannot bid certain cost components and physical limits, they will find ways to include these cost in prices they can bid, and they will find ways to compensate for their limitations. These adjustments will typically be imperfect, but if the problem is fairly small to begin with, the adjustments usually will be more than adequate. In spite of this optimistic view, there are no guarantees, and it makes sense to investigate the performance of markets with known imperfections. It also makes sense to avoid rigid restrictions such as a restriction to 1-part bids. Because markets are good at taking advantage of whatever flexibility is available, adding a second part to the bid may significantly improve the outcome. By the same token, adding 20 parts to the bid is almost surely overkill.
Units
Startup costs are measured in $ per MW of capacity started. For a unit that is started once per day, the cost flow is most conveniently measured in $/MWday. For comparability, energy and fixed costs will also be converted to $/MWday in many of the examples.
Chapter
3-8
MARKET FOR OPERATING RESERVES PAYS GENERATORS TO BEHAVE DIFFERENTLY FORM HOW THE ENERGY MARKET SAYS THEY SHOULD.
If they are cheap and would produce at full output, the market might tell them to produce less. If they are too expensive to produce at all, it may tell them to start spinning, and this may require them to produce at a substantial level. The purpose is to increase reliability. Spinning reserve (spin) is the most expensive type of reserve because a generator must be operating (spinning) to provide it. Spin is typically defined as the increase in output that a generator can provide in ten minutes.22 Steam units can typically ramp up (increase output) at a rate of 1% per minute which allows them to provide spin equal to 10% of their capacity.23 Spin can also be provided by load that can reliably back down by a certain amount in ten minutes. The next lower qualities of operating reserves are ten-minute non-spinning reserves, typically provided by combustion turbines, and 30-minute nonspinning reserves. This chapter will consider only spinning reserve because it is the most critical and illustrates many important design problems. Spin can range from free to expensive. Incidental spin is provided by generators that are not fully loaded simply because they are marginal and their entire output is not required, but more often because they are in the process of
22 23
This value can be improved by the generator owner, and markets may lead to such improvements.
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ramping down. Sometimes generators are given credit for spin when they are ramping up at full speed to keep up with the morning ramp. While these may meet the letter of the definition, they do not meet its spirit because they could not help to meet an contingency such as another generator dropping off line. Typically the spinning reserve requirement of a system is roughly equal to the largest loss of power that could occur due to a single line or generator failure, a single contingency. Providing spin from generators that would not otherwise run is costly for several reasons. Most importantly, generators usually have a minimum generation limit below which they cannot operate and remain stable. If this limit requires a generator to produce at least 60 MW, and its marginal cost is $10/MWh above the market price, and it can provide 30 MW of spin, this spin costs $20/MWh. In addition there would be a no-load cost due to power usage by the generator that is unrelated to its output. Startup costs should also be included. Providing spin from infra-marginal generators, ones with marginal costs below the market price, is also expensive. If a cheap generator has been backed down slightly from full output, its marginal cost may be only $20/MWh while the competitive price is $30/MWh. In this case, backing it down one MW will save $20 of production cost but will require that an extra MW be produced at $30/MWh. The MW of spin provided costs $10/MWh. Sometimes it is necessary to provide spin in this manner because too little is available from marginal and extra-marginal generators. This is typically the case when the market price reaches $100/MWh. The three operating reserve markets are tightly coupled to each other and to the energy market. California demonstrated the folly of pretending differently and managed to pay $9,999/MWh hour for a class of reserves lower than 30-minute non-spin at times when the highest quality reserves were selling for under $50/MWh.24 This chapter will not consider the problem of how the markets should be coupled, although the most straightforward answer indicates they should be cleared simultaneously using a single set of bids that can be applied to any of the markets. Section 1: Scoring by Expected Cost. One approach to conducting a market for spin is to have suppliers submit two-part bids, a capacity price, R,
24
The root of this problem was a market separation ideology, although several peculiar rules played a role as did FERC.
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25
This approach was developed by Robert Wilson for the California ISO, and is explained along with the problems of expected-cost bidding in (Chao and Wilson, 2001).
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raises some of the same gaming issues as two-part bid evaluation. These remain to be investigated.
Bidders true expected costs: Bidders bid: Bidders score (S): Bidders expected payoff: Bidders expected profit:
The lowest score wins. Say the bidder wants to achieve a score of S. It must choose R = S H!P, where it is free to choose any energy price, P. With this choice, profit will be: profit = (S H!P ) + h!P (C + h!MC ), or profit = S (C + h!MC ) + (h H ) P.
S (C + h!MC ) is unaffected by the bidders choice of P, so profit is controlled by the term (h H) P. For any given score, S, the bidder can achieve any profit
level by choosing the correct P ! The choice of P will determine the bidders choice for R, as described, but together P and R will produce any desired level of profit and any desired score. This depends on the bidder knowing h, and the system operator choosing H h . If H < h, then the bidder should bid an extremely high price for energy and a low cost for capacity. If H > h, the