Report 1.1: Energy Pricing

by Alan Ransil 23 August 2018

Protocol Labs, MIT Thank you to Sandhya Prabhu, MITei, for help with LMP methodology

Contents

1 Introduction: overview of GTDR system design

2 Pricing in the bulk power system

2.1 The simple case: no transmission constraints or losses.
2.2 Locational marginal pricing.
2.3 Multisettlement Systems and the rationale behind auctions.
2.4 Ancillary services.

3 Pricing in retail markets

3.1 Retail rate setting in regulated markets. 3.2 Other retail market arrangements. 3.3 Why don’t retail customers pay time of use rates?

1. Introduction: overview of GTDR system design

This project has two overall goals, as described in the work plan. Firstly, it will identify value propositions that an open-source energy trading protocol can provide as the power grid is restructured to accommodate increased penetration of renewable energy. Second, it will outline the design of such a protocol.

This first report focuses on the mechanisms by which electricity is priced in today’s power markets. Existing energy markets govern the infrastructure that any widely-used trading protocol must interface with in the short and medium terms. They also suggest operational requirements that a protocol must satisfy in the long-term, if it is to eventually replace existing systems or become a ubiquitous platform upon which future wholesale markets are built.

Power grids throughout the world are based on a Generation, Transmission, Distribution and Retail (GTDR) model. The system is highly centralized, with radial power flows from large power stations to small consumers. In the US in 2016, there were 8,084 power plants above 1MW nameplate generation capacity and over 150M retail customers, implying that each generating facility serves on average 18.6 thousand retail nodes.

The division between Transmission and Distribution results from a need to minimize losses between Generation and Retail nodes. As power plants are in general far from retail customers, the electricity they produce must be transmitted over long distances.

This report will explain the dominant pricing mechanisms in both of these markets, and then highlight some variations and exceptions to these general principles.

2. Pricing in the bulk power system

Power grids are grouped into interconnections that tend to cover broad areas. The United States has three interconnections. One covers its western half and another covers its east. Texas has its own.

Large sections of power grids operate synchronously, meaning that they operate at the same frequency in phase across the entire grid. Because all major power grids have very little storage capability, a balancing authority must coordinate injections and monitor withdrawals from the system.

2.1. The simple case: no transmission constraints or losses

System operators, for example, ISOs, typically run wholesale markets using an auction system. The market clearing price results from the auction where every producer should bid their marginal cost of production. If a producer bids too low, they may produce power at a loss; if too high, they risk being undispersed.

In a typical fossil fuel power station, the marginal cost is determined by the cost of fuel. The ISO constructs a supply curve and the market clearing price defines the cost of power on the grid. All generators that bid prices below or equal to this price are dispatched and are paid at this price.

2.2. Locational marginal pricing

In reality, power transmission lines exhibit losses and transmission constraints, leading to nonuniform costs. Locational Marginal Prices (LMPs) generate price signals that vary across the grid based on location.

LMPs are calculated based on various factors including the effect of changing power injection at a location and total system-level generation costs.

LMP Calculation Steps:

1. Solve Optimal Power Flow to minimize total system-level generation cost.
2. Determine the effects of changing injections on total system losses and generation costs.
3. Calculate the marginal cost at each location based on the overall market clearing price and system-level losses.

2.3. Multisettlement Systems and the rationale behind auctions

Power markets are ‘multisettlement’ systems where trades are committed at distinct time points prior to actual consumption. Auctions are structured to maintain balance in the system and ensure market liquidity.

2.4. Ancillary services

Markets for Ancillary Services (AS) ensure grid reliability. Common AS include forward capacity and reserve markets, which provide compensation for readiness and reliability support.

3. Pricing in retail markets

The process of delivering and selling electricity is carried out in the Distribution and Retail (DR) system. Electricity retailers purchase power in wholesale markets and through long-term contracts, selling power to consumers at rates approved by regulators.

3.1. Retail rate setting in regulated markets

Investor Owned Utilities (IOUs) operate as monopolies, requiring rate schedules to be approved by local regulators. Rates are based on various customer classes and charges.

3.2. Other retail market arrangements

Trends towards deregulation of retail markets allow customers to purchase supply from competing retailers, encouraging price stability and energy efficiency.

3.3. Why don’t retail customers pay time of use rates?

Electricity is considered a public good; hence it must remain affordable. Technical limitations historically hinder the implementation of time-of-use rates. Regulated utilities are also structured to protect consumers from price spikes.

References

[1] United States Environmental Protection Agency. U.s. electricity grid and markets. [2] Queensland Competition Authority. Electricity facts. [3] ISO New England. Overview of new england’s wholesale electricity markets and market oversight. [4] ISO New England Litvinov, Eugene. Power system and lmp fundamentals. [5] Midwest Independent System Operator. Midwest iso real-time lmp map.