part0.pdf

© February2002. Steven Stoft, Power System Economics (IEEE/Wiley) ISBN 0-471-15040-1.

Power SystemEconomics

Designing Markets for Electricity

S t e v e n S t o f tIEEE / Wiley


Cover painting by W. Louis Sonntag, Jr. (1869-1898), The Bowery atNight, c. 1895. Early deregulated electricity market with trolleys poweredby Westinghouse’s AC and shops probably illuminated with Edison’s DC.The houses may still be lit by gas. The “Third Avenue Elevated” (1878),whose noise and shadows contributed to the decline of New York’s once-elegant theater district, will soon be electrified. (Uncle Tom’s Cabin wasfirst staged in the Bowery Theatre visible at the extreme left.) Arc lights,brought to New York streets in 1880 by Charles Brush, transformed nightlife. Sonntag frequently depicted the resulting sense of glamour and ex-citement. The watercolor was a Gift of Mrs. William B. Miles to the Mu-seum of the City of New York.


For my mother, whose writing inspired me to think I could,and my father who taught me to test high voltage with one hand behind my back


Contents in BriefList of Results and Fallacies xivPreface xviiiAcronyms and Abbreviations xxSymbols xxii

Part 1. Power Market FundamentalsPrologue 2Why Deregulate? 6What to Deregulate 17Pricing Power, Energy, and Capacity 30Power Supply and Demand 40

What Is Competition? 49Marginal Cost in a Power Market 60Market Structure 74Market Architecture 82Designing and Testing Market Rules 93

Part 2. Reliability, Price Spikes and InvestmentReliability and Investment Policy 108Price Spikes Recover Fixed Costs 120Reliability and Generation 133Limiting the Price Spikes 140Value-of-Lost-Load Pricing 154

Operating-Reserve Pricing 165Market Dynamics and the Profit Function 174Requirements for Installed Capacity 180Inter-System Competition for Reliability 188Unsolved Problems 194

Part 3. Market ArchitectureIntroduction 202The Two-Settlement System 208Day-Ahead Market Designs 217Ancillary Services 232The Day-Ahead Market in Theory 243

The Real-Time Market in Theory 254The Day-Ahead Market in Practice 264The Real-Time Market in Practice 272The New Unit-Commitment Problem 289The Market for Operating Reserves 306

Part 4. Market PowerDefining Market Power 316Exercising Market Power 329Modeling Market Power 337

Designing to Reduce Market Power 345Predicting Market Power 356Monitoring Market Power 365

Part 5. Locational PricingPower Transmission and Losses 374Physical Transmission Limits 382Congestion Pricing Fundamentals 389Congestion Pricing Methods 395Congestion Pricing Fallacies 404

Refunds and Taxes 411Pricing Losses on Lines 417Pricing Losses at Nodes 424Transmission Rights 431

Glossary 443References 455Index 460


Contents

List of Results and Fallacies xivPreface xviiiAcronyms and Abbreviations xxSymbols xxii

Part 1. Power Market Fundamentals Prologue 2Reading to Different Depths 3Reading Out of Order 4

1-1 Why Deregulate? 6Conditions for Deregulation 9Problems with Regulation 10The Benefits of Competitive Wholesale Markets 12The Benefits of Real-time Rates 13Problems with Deregulating Electricity 14

1-2 What to Deregulate 17Ancillary Services and the System Operator 19Unit Commitment and Congestion Management 22Risk Management and Forward Markets 25Transmission and Distribution 25Retail Competition 26

1-3 Pricing Power, Energy, and Capacity 30Measuring Power and Energy 32Measuring Generation Capacity 33Pricing Generation Capacity 33Technical Supplement 39

1-4 Power Supply and Demand 40Describing the Demand for Power 41Screening Curves and Long-Run Equilibrium 44Frequency, Voltage, and Clearing the Market 45


Contents ix

1-5 What Is Competition? 49Competition Means More than “Struggle” 51The Efficiency of Perfect Competition 52 Short- and Long-Run Equilibrium Dynamics 56Why Is Competition Good For Consumers? 59

1-6 Marginal Cost in a Power Market 60The Role of Marginal Cost 62Marginal-Cost Fallacies 63The Definition of Marginal Cost 65Marginal Cost Results 67Working with Marginal Costs 69Scarcity Rent 70

1-7 Market Structure 74Reliability Requirements 76Transmission 77Effective Demand Elasticity 78Long-Term Contracts 80Supply Concentration 80

1-8 Market Architecture 82Listing the Submarkets 84Market Types: Bilateral through Pools 86Market Linkages 89

1-9 Designing and Testing Market Rules 93Design for Competitive Prices 95Design to Prevent Gaming 98Auctions 99Testing a Market Design 101Technical Supplement: Example of a “Bottom-Line Test” 103

Part 2. Reliability, Price Spikes, and Investment 2-1 Reliability and Investment Policy 108

Price Regulation is Essential 111The Profit Function 114Side Effects of Reliability Policy 116Inter-System Competition 117Demand-Side Effects of Price Limits 118

2-2 Price Spikes Recover Fixed Costs 120The Fixed-Cost Fallacy 121Optimal Price Spikes for Peakers 123The Lumpiness of Fixed Costs 129


x Contents

2-3 Reliability and Generation 133Operating Reserves and Contingencies 134Adequacy and Security 135The Simple Model of Reliability 136The Fundamental Reliability Question 139

2-4 Limiting the Price Spikes 140Normal Market Operation with Limited Demand Elasticity 142Market Failure with a steep load-duration curve 144Suppressing the Balancing Market to Avoid Regulating Price 145Setting Price to the Last Clearing Price 148How Real-Time Price Setting Caps the Forward Markets 150Technical Supplement: The Condition for Failure 152

2-5 Value-of-Lost-Load Pricing 154Valuing Lost Load 155VOLL Pricing is Optimal in the Simple Model of Reliability 157Practical Considerations 159Technical Supplement 163

2-6 Operating-Reserve Pricing 165Less Risk, Less Market Power 166How Can OpRes Pricing Be Better than Optimal? 172

2-7 Market Dynamics and the Profit Function 174Calculating Profit Functions 175Interpreting the Profit Function 177

2-8 Requirements for Installed Capacity 180The Capacity-Requirement Approach 181Short-Run Profits with a Capacity Requirement 182Combining a Capacity Requirement with a Price Spike 184Comparing the Two Approaches 186

2-9 Inter-System Competition for Reliability 188Price-Cap Competition 189Competition between Price Spikes and Capacity Requirements 191

2-10 Unsolved Problems 194High Marginal Costs and Low Price Caps 195Pricing Supply and Demand Separately 197Price-Elastic Demand for Operating Reserves 197The Psychology of System-Operators 198

Part 3. Market Architecture 3-1 Introduction 202

Spot Markets, Forward Markets and Settlements 203Architectural Controversies 204Simplified Locational Pricing 206


Contents xi

3-2 The Two-Settlement System 208The Two-Settlement System 209Ex-Post Prices: The Trader’s Complaint 214

3-3 Day-Ahead Market Designs 217How Day-Ahead Auctions Determine Quantity and Price 218Summaries of Four Day-Ahead Markets 223Overview of the Day-Ahead Design Controversy 230

3-4 Ancillary Services 232The List of Ancillary Services 233Real-Power Balancing and Frequency Stability 236Voltage Stability for Customers 238Transmission Security 238Economic Dispatch 240Trade Enforcement 240

3-5 The Day-Ahead Market in Theory 243Equilibrium Without a Clearing Price 244Difficulties with Bilateral Day-Ahead Markets 247Settlement, Hedging, and Reliability 250Other Design Considerations 252

3-6 The Real-Time Market in Theory 254Which Trades Are Part of the Real-Time Market? 255Equilibrium Without a Market-Clearing Price 258Why Real-Time Markets Are Not Purely Bilateral 261

3-7 The Day-Ahead Market in Practice 264Arbitrage vs. Computation 265Efficiency 268Reliability and Control 269Risk Management 270

3-8 The Real-Time Market in Practice 272Two Approaches to Balancing-Market Design 274The Marginal-Cost Question As Decided by FERC 277Making Sense of the Marginal-Cost Pricing Charade 279The Power Exchange Approach 285

3-9 The New Unit-Commitment Problem 289How Big Is the Unit-commitment problem? 291Unit Commitment in a Power Exchange 294Investment Under a Power Pool 302

3-10 The Market for Operating Reserves 306Types of Operating Reserve 307Scoring by Expected Cost 309Scoring Based on the Capacity Bid Only 310Opportunity-Cost Pricing 313


xii Contents

Part 4. Market Power 4-1 Defining Market Power 316

Defining Market Power 318Defining Price-Quantity Outcomes 319Three Stages of Market Power 321Using Price-Quantity Outcomes to Show Market Power 323Monopoly Power in a Power Auction 326Market Power on the Demand Side 327

4-2 Exercising Market Power 329Market Power and Forward Markets 330Long-Run Reactions to Market Power 331Marginal and Nonmarginal Generators 332The Two Effects of Market Power 333Long-Run and Short-Run Market Power 334Is a 1000% Markup Too Much? 336

4-3 Modeling Market Power 337Monopoly and the Lerner Index 338The Cournot Model 340Unilateral Action and the HHI 342Technical Supplement: Markup Determination 343

4-4 Designing to Reduce Market Power 345Demand Elasticity and Supplier Concentration 346What Keeps Prices Down? 347Forward Contracts and Obligations 347Demand Uncertainty and Supply-Curve Bidding 351Technical Supplement: Calculations for Section 4-4.3 353

4-5 Predicting Market Power 356Four Factors that HHI Ignores 357Why the Lerner Index Is Unreliable 358Estimating Market Power 361Technical Supplement: Market Power and Forward Contracts 363

4-6 Monitoring Market Power 365FERC’s Ambiguous Standard 366Market Monitoring 368

Part 5. Locational Pricing 5-1 Power Transmission and Losses 374

DC Power Lines 375AC Power Lines 378

5-2 Physical Transmission Limits 382Thermal Limits on Power Lines 383Reactive Power and Thermal Limits 384Stability Limits on Power Lines 386


Contents xiii

5-3 Congestion Pricing Fundamentals 389Congestion Pricing Is Competitive Pricing 390Benefits of Competitive Locational Prices 393

5-4 Congestion Pricing Methods 395Centralized Computation of CLPs 396Bilateral Pricing Compared to Centralized Pricing 399

5-5 Congestion Pricing Fallacies 404Are Competitive Locational Prices Too High? 404Congestion Taxing 408

5-6 Refunds and Taxes 411Pricing Versus Taxing 412Energy Taxes 414

5-7 Pricing Losses on Lines 417The Competitive Price is Twice the Average Cost 418Competitive Losses Pricing 419Inefficiency of Average-Cost Loss Pricing 421

5-8 Pricing Losses at Nodes 424Nodal Loss Prices 425Full Nodal Pricing: Loss, Congestion and Reference Prices 427Three Common Restrictions on Losses Pricing 429

5-9 Transmission Rights 431The Purpose of Transmission Rights 432Using Financial Transmission Rights 435Revenues from System-Issued Financial Rights 437Physical Transmission Rights 440

Glossary 443References 455Index 460


List of Results and Fallacies

1111 The Efficient-Competition Result 10101010 The Price-Cap Result2222 The Marginal-Cost Pricing Result 11111111 The Contracts-for-Differences Result 13333 The Marginal-Cost Fallacy 12121212 The Contracts-for-Differences Result 24444 The Ambiguous-Price Fallacy 13131313 The Efficient-Auction Result5555 The System-Marginal-Cost Pricing Result 14141414 The HHI Result6666 The Fixed-Cost Fallacy 15151515 The Market-Power Fallacy7777 The Weak Fixed-Cost Fallacy 16161616 Locational-Pricing Result 18888 The Reliability Fallacy 17171717 Locational-Pricing Result 29999 The Regulatory-Price-Spike Result 18181818 The Locational-Pricing Fallacy

Part 1. Power Market FundamentalsWhy Deregulate?

Result 1-1.1 Savings from Real-Time Rates Would Be Small 14Pricing Power, Energy, and Capacity

FallacyFallacyFallacyFallacy 1-3.1 Fixed and Variable Costs Are Measured in Different Units 34Result 1-3.2 Energy, Power, and Capacity Are Priced in $/MWh 36

Power Supply and DemandResult 1-4.1 Supply Equals Consumption but May Not Equal Demand 48

What Is Competition?1111 Result 1-5.1 Competitive Prices Are Short- and Long-Run Efficient 542222 Result 1-5.2 Competitive Suppliers Set Output So That MC = P 57

Result 1-5.3a Under Competition, Average Economic Profit Is Zero 58Result 1-5.3b Under Competition, Fixed Costs Are Covered 58Result 1-5.3c A Supplier with a Unique Advantage Can Do Better 58

Marginal Cost in a Power Market3333 FallacyFallacyFallacyFallacy 1-6.1 Marginal Cost Equals the Cost of the Last Unit Produced 644444 FallacyFallacyFallacyFallacy 1-6.2 When Marginal Cost Is Ambiguous, so Is the Competitive Price 65

Result 1-6.1 Competitive Suppliers Set Output so MCLH <– P <– MCRH

5555 Result 1-6.2 Competitive Price Equals System Marginal Cost 68Result 1-6.3 Supply Intersects Demand at the Competitive Price 69

Market ArchitectureResult 1-8.1 The Forward Price Is the Expected Future Spot Price 90

Designing and Testing Market RulesFallacyFallacyFallacyFallacy 1-9.1 Scarcity Rents Are Unfair 95Result 1-9.1 Changing the Market’s Rules Changes Behavior 97Result 1-9.2 Design Market Mechanisms to Induce Truth Telling 99Result 1-9.3 Four Types of Auctions Produce the Same Revenue 100Result 1-9.4 A Vickrey Auction Is Incentive Compatible 100


List of Results and Fallacies xv

Part 2. Reliability, Price Spikes, and InvestmentPrice Spikes Recover Fixed Costs

6666 FallacyFallacyFallacyFallacy 2-2.1 Marginal-Cost Prices Will Not Cover Fixed Cost 121Result 2-2.1 In the Long-Run, Suppliers Recover Their Fixed Costs 123Result 2-2.2 Long-Run Equilibrium Conditions for Two Technologies 128

7777 FallacyFallacyFallacyFallacy 2-2.2 Marginal-Cost Pricing Causes a Capacity Shortage 129Result 2-2.3 Marginal-Cost Prices Induce the Optimal Mix of Technologies 129Result 2-2.4 Inefficiency Caused by the Lumpiness of Generators Is Negligible 131

Reliability and GenerationResult 2-3.1 Optimal Duration of Load Shedding Is D*

LS = FCpeak'VLL 139Limiting the System’s Price

Result 2-4.1 A Small Amount of Elastic Demand Can Make the Market Efficient 143Result 2-4.2 Too Little Demand Elasticity Can Cause the Real-Time Market to Fail 145Result 2-4.3 Suppressing the System Operator’s Balancing Market Is Inefficient 147

8888 FallacyFallacyFallacyFallacy 2-4.1 The “Market” Will Provide Adequate Reliability 111, 1479999 Result 2-4.4 Regulatory Policy Determines the Height and Duration of Price Spikes 114, 147

Result 2-4.5 Do Not Cap Prices at the Highest Demand Bid 15010101010 Result 2-4.6 The Real-Time Price Limit Effectively Caps the Entire Market 113, 152

Result 2-4.7 Conditions for the Failure of a Power Market 152Result 2-4.8 Conditions for an Efficient Power Market 153

Value-of-Lost-Load PricingFallacyFallacyFallacyFallacy 2-5.1 VOLL Cannot Be Usefully Defined 156Result 2-5.1 Within the Simple Model of Reliability, VOLL Pricing Is Optimal 159Result 2-5.2 Inaccuracy of Estimation Does Not Rule Out the Use of VOLL 159FallacyFallacyFallacyFallacy 2-5.2 Risk from VOLL Pricing Is Beneficial 161

Operating-Reserve PricingResult 2-6.1 Many Different Price Limits Can Induce Optimal Investment 116, 168Result 2-6.2 A Lower, Longer-Duration Aggregate Price Spike Is Less Risky 169Result 2-6.3 High Price Caps Invite the Exercise of Market Power 171Result 2-6.4 Reliability Policy Should Consider Risk and Market Power 117, 173

Market Dynamics and the Profit FunctionResult 2-7.1 The Higher the Price Spikes, the Steeper the Profit Function 177Result 2-7.2 Steeper Profit Functions Increase Risk and Market Power 178

Requirements for Installed CapacityResult 2-8.1 Energy and Capacity Prices Together Induce Investment 115, 181Result 2-8.2 A Capacity Requirement Can Eliminate the Need for Price Spikes 184Result 2-8.3 VOLL Pricing Induces Optimal ICap Even When ICap Is Random 185Result 2-8.4 Profit Functions Are Additive, But Resulting Profits Are Not 186

Inter-System Competition for ReliabilityResult 2-9.1 Competition Between System Operators Induces High Price Spikes 118, 190Result 2-9.2 Trading between Markets with Different Policies Can Reduce Reliability 191Result 2-9.3 Capacity-Requirement Markets Need Annual Requirements 192

Unsolved ProblemsResult 2-10.1 The Price of Operating Reserves Should Increase When They Are Scarce 198


xvi List of Results and Fallacies

Part 3. Market ArchitectureThe Two-Settlement System

Result 3-2.1 A Two-Settlement System Preserves Real-Time Incentives 21011111111 Result 3-2.2 A Contract for Differences Insulates Traders from Spot Price Volatility 21212121212 Result 3-2.2 Contracts for Differences Preserve Real-Time Incentives 213

Day-Ahead Market Designs13131313 Result 3-3.1 A Single-Price Day-Ahead Auction Is Efficient 220

Ancillary ServicesResult 3-4.1 Strictly Bilateral Power Trading Requires Centralized Coordination 241

The Day-Ahead Market in TheoryResult 3-5.1 A Bilateral DA Market Decreases Reliability 249Result 3-5.2 Side-Payments in a Day-Ahead Pool Do Not Increase Reliability 252

The Real-Time Market in TheoryResult 3-6.1 Real-Time Power Is Not Bought or Sold Under Contract 256Result 3-6.2 Real-Time Pools Sometimes Require Direct Control of Generation 259

The Day-Ahead Market in PracticeResult 3-7.1 A Day-Ahead Power Pool Is Not Required for Reliability 269

The Real-Time Market in PracticeResult 3-8.1 SMC Unit Commitment with Elastic Demand Is Inefficient 283Result 3-8.2 System-Marginal-Value Pricing Provides Efficient Demand Incentives 284

The New Unit-Commitment ProblemResult 3-9.1 A Power Exchange’s Unit-Commitment Inefficiency Is Less Than 1%. 293Result 3-9.2 Marginal Cost Prices Can Solve Some Unit-Commitment Problems 294Result 3-9.3 A Power Exchange Lacks a Classic Competitive Equilibrium 297Result 3-9.4 A Power Pool with Accurate Bids Induces the Optimal Dispatch 297Result 3-9.5 Two-Part Bids Can Solve Some Unit-Commitment Problems 298Result 3-9.6 A Power Exchange Has a Nearly-Efficient Nash Equilibrium 300Result 3-9.7 Side Payments in Power Pools Distort Investment in Generation 303

The Market for Operating ReservesResult 3-10.1 Capacity-Bid Scoring for Spinning Reserves Is Optimal

Part 4. Market PowerDefining Market Power

Result 4-1.1 Monopoly Power Always Causes the Quantity Withheld to be Positive 325Result 4-1.2 When Assessing Monopoly Power, Ignore Demand-Side Flaws 325Result 4-1.3 Profitably Raising the Market Price May Not Be Market Power 326

Exercising Market PowerResult 4-2.1 Market Power Cannot Be Exercised in Day-Ahead Power Markets 331Result 4-2.2 The Bid that Raises the Price May Not Set the Price 332

Modeling Market Power14141414 Result 4-3.1 The Average Lerner Index Equals HHI Over Demand Elasticity 342

Predicting Market PowerResult 4-5.1 Price Distortion Measures Market Power Better 361

Monitoring Market Power15151515 FallacyFallacyFallacyFallacy 4-6.1 Some Market Power Is Needed and Beneficial 370

FallacyFallacyFallacyFallacy 4-6.2 Market Power Cannot Be Proven 370


List of Results and Fallacies xvii

Part 5. Basic Locational PricingPower Transmission and Losses

Result 5-1.1 Kirchhoff’s Laws 376Result 5-1.2 Power Equals Voltage Times Current (Volts × Amps) 377Result 5-1.3 Ohm’s Law Is Voltage Equals Current Times Resistance (I × R) 377Result 5-1.4 Transmission Losses Are Proportional to Power2 / Voltage2 378

Physical Transmission LimitsResult 5-2.1 Thermal Limits Depend on Real and Reactive Power Flows 385

Congestion Pricing FundamentalsResult 5-3.1 Transmission Price AûB Is the Power Price Difference, PB !! PA 392

16161616 Result 5-3.2 Only Competitive Locational Prices Minimize Total Production Cost 394Congestion Pricing Methods

Result 5-4.1 Power Flows Are Approximately Additive 39717171717 Result 5-4.2 Competitive Bilateral Prices Equal Centralized Locational Prices 401

Congestion Pricing Fallacies18181818 FallacyFallacyFallacyFallacy 5-5.1 Congestion Rent > Redispatch Cost Is Unfair to Consumers 406

Refunds and TaxesResult 5-6.1 Price for Efficiency and Not to Raise Revenue 414Result 5-6.2 Tax for Revenue and Not to Improve Efficiency 414Result 5-6.3 An Energy-Based Transfer from Generators to Loads has No Net Effect 415Result 5-6.4 An Energy Tax on Load or Generation Will Be Paid by Load 416

Pricing Losses on LinesResult 5-7.1 Marginal Losses Are Twice Average Losses 418Result 5-7.2 The Competitive Charge for Transmission Is Twice the Cost of Losses 419Result 5-7.3 Competitive Bilateral Loss Prices Equal Marginal Cost 421Result 5-7.4 Average-Cost Loss Pricing Raises the Cost of Production 423

Pricing Losses at NodesResult 5-8.1 Changing the Reference Bus Changes Loss Prices Uniformly 427Result 5-8.2 Changing the Reference Bus Does Not Affect Bilateral Trades 427

Transmission RightsResult 5-9.1 Trading Opportunities Are Not Blocked by Congested Lines 433Result 5-9.2 Revenue from a Feasible Set of TCCs Will Be Sufficient 439Result 5-9.3 The Feasible Set of Physical Rights Cannot Account for Counterflows 440


Preface

My original purpose in writing this book was to collect and present the basiceconomics and engineering used to design power markets. My hope was to dispelmyths and provide a coherent foundation for policy discussions and market design.In the course of writing, I came to understand there is no received wisdom to presenton two key issues: price-spikes and pools. While the majority of the book still holdsto my first purpose, Parts 2 and 3 are guided as well by a second. They seek topresent the two unresolved issues coherently, answer a few basic questions andhighlight some of the gaps in our current understanding.

The price-spike issue is how to design the market to accommodate two demand-side flaws underlying the price-spikes that provide incentives for investment ingeneration. Part 2 shows that some regulation is required until one flaw has beenmitigated. The first regulatory goal should be to ensure the revenue from theaggregate price spike is just sufficient to induce a reliable level of generatingcapacity. This revenue is determine by (1) the duration of the aggregate price spikewhich is under the influence of NERC guidelines and (2) the height of the pricespike which is regulated by FERC. Currently, neither institution appears aware theirpolicies jointly determine investment.

Part 2 provides a framework for computing the level of investment induced byany combination of NERC and FERC policies. Because many combinations willwork, it suggests a second goal. Price volatility should be reduced to levels thatmight be expected from a mature power market—levels far below those observedin the current markets with their incapacitated demand sides. I hope Part 2 willclarify the regulatory options and the need to fix the market’s demand side.

While Part 3 presents the standard principles of bilateral markets, exchangesand pools, it is able to make little progress on the second issue, the power-poolquestion. An exchange is a widely used form of centralized market—the New YorkStock Exchange is an example—while pools are peculiar to power markets. Ex-changes trade at one price at any given time and location, while pools pay differentprices to different generators according to their costs. The differences in transpar-ency and operation are considerable as may be their performance. Unfortunately,little theoretical or empirical research is to be found, and Part 3 can only raise issuesand show the answers are far from obvious.

While three pools operate in the eastern U.S. and PJM has been deregulatedfor nearly four years, no evaluation of their efficiency has been undertaken. Theonly national effort, a shoestring operation at the Department of Energy, has beencrippled by lack of access to data that FERC could easily obtain from the pools.Pro-pool forces within FERC have, for years, blocked any suggestion to evaluatethe performance of pools or their potential benefits. No description of any eastern


Preface xix

pool, suitable for economic analysis, can be found within FERC or in the publicdomain.

Theoretical pool descriptions cover ex-ante pricing while knowledgeableobservers indicate the eastern ISOs use ex-post pricing. This is said to be basedon a philosophy of controlling quantities in real-time and computing prices afterthe fact. In practice, it involves proprietary calculations that apparently assumethe operator’s actions were optimal. I could discover no useful discussion of thetheory of this critical issue, so readers of Part 3 must wait for a later edition.

Competitive power markets, like regulated markets, must be designed anddesigned well. Because of the poor quality of many current designs and the lackof a well-tested standard, this book does not recommend a rush to deregulate. Agiven deregulation may succeed, but economic theory cannot predict when sucha complex political process, once begun, will be out-maneuvered by the forces itseeks to harness. If a market is being designed or redesigned, this book is meantto help; if the decision is to wait, this book is meant to make the wait shorter.

Acknowledgments

Those who undertook to read, correct and criticize drafts provided an invaluableservice and deserve thanks from all of my readers, whom they have protected frommany confusions, diversions, and errors. For this difficult undertaking I am espe-cially grateful to Ross Baldick, Joe Bowring, Haru Connally, Rob Gramlich, DougHale, Alex Henney, Bill Hogan, Mat Morey, Sabine Schnittger, and Jurgen Weiss.

Many others have made more narrowly focused but still invaluable contributions.They provided an ongoing discussion on many topics and constantly provided freshviews and caught errors. Thanks to Darwin Anwar, Gerry Basten, RichardBenjamin, Severin Borenstein, Jason Christian, Ed Mills, Udi Helman, MikeRothkopf, Erik Hirst, Ben Hobbs, Mangesh Hoskote, Marcelino Madrigal, DaveMead, Joshua Miller, Alan Moran, Jim Kritikson, Dan Gustafson, Frank Felder,Carl Fuchshuber, Richard Green, Harry Singh, Alasdair Turner, Hugh Outhred,Gail Panagakis, Alex Papalexopolous, Gregory Werden, and James Wightman.

Without the patient support of the IEEE/Wiley staff, John Griffen, TonyVengraitis, and Andrew Prince, none of this would have been possible. My copyeditor, Susan Ingrao, has been a pleasure to work with and tremendously informa-tive, even answering arcane typesetting questions. Remaining errors are the resultof my inaccurate corrections or last minute changes.

For support and guidance on every challenge, I have turned first to my wifePamela who has been my creative advisor, editor, and legal counsel. I thank herfor her abundant patience and unerring judgement.

But of all those who have contributed to this book, I owe the most to my mother,Dorothy, who brought her artistry to the dull world of power economics. Throughthree complete drafts, she gently but persistently corrected and shaped, guided andpolished. While the quality of my writing still falls far short of my mother’s, itdelights me to have learned, at last, a little of her art.


Acronyms and Abbreviations

AC alternating currentACE area control error

CA ISO California Independent System OperatorCFD contract for differencesCLP competitive locational priceCR capacity requirementDA day ahead

DOJ Department of JusticeFERC Federal Energy Regulatory Commission

FTR financial transmission rightFTC Federal Trade CommissionGT gas turbine generator

HHI Herfindahl-Hirschman index ICap installed capacity

IPP independent power producerISO independent system operator

ISO-NE ISO New EnglandLBMP locational-based marginal priceLHMC left-hand marginal cost

LMP locational marginal priceLRMC long-run marginal cost

MC marginal costNERC North American Electric Reliability Council

NYISO the New York Independent System Operator, Inc.NYSE the New York Stock Exchange

NE Nash equilibriumOpRes operating reserve

PJM Pennsylvania-New-Jersey-Maryland Independent System OperatorPTR physical transmission right

RHMC right-hand marginal costRT real time (market)

RTO regional transmission organizationSMC system marginal costSMV system marginal value

TR transmission rightUC unit commitment

VOLL value of lost load


Acronyms and Abbreviations xxi

Units Used to Measure ElectricityV volt The unit of electrical pressureA amp The unit of electrical currentW watt Power (Energy per hour)h hour Time

Wh watt-hour Energyk kilo 1000. Used in kW, kWh and kV.

M mega 1,000,000. Used in MW and MWh.G giga 1,000,000,000. Used in GW.T tera 1012. Used in TWh.


Symbols

Units Symbol Definition

� e, �* equilibrium and optimal superscripts�peak , �mid , �base peakload, intermediate, and baseload generating capacity subscripts

�1, �0 day-ahead, and real-time subscripts�A , �B bus-A, bus-B subscripts

$/MWh ACE average cost of energy for a load slice$/MWh ACK average cost of purchasing and using capacity for a load slice$/MWyear ARR annual revenue requirement of a generator$/MWh CC cost of providing spinning-reserve capacity.none cf capacity factornone C cost of Productionnone DLS duration of load shedding (Lg > K)none DPS duration of price spike (Lg + ORR > K)none Dpeaker duration of peaker use (Lg + ORR > Kbase)none e price elasticity of demandMWh E energy$/MWh FC fixed cost$/MWh FT current price of a future for delivery at time TMW g generation out of servicenone h true probability of needing spinning reservesnone h estimated hamps I electrical currentMW K installed generating capacity (ICap)MW Kn e average K in an equilibrium when K is random.


Mega What

2 Pages of Symbols Missing

part0.pdf

Documents

exercising market power

predicting market power

monitoring market power

modeling market power

pricing power

realtime market

market dynamics

market structure