Congestion Pricing: Competitive Locational Prices of Power
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Congestion Pricing:Competitive Locational Prices of Power
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. PAB = PB - PA
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: (40 + 300/50) = $46 MWh
Price of power at Bus 2: (20 + 600/50) = $32 MWh
Price of Transmission
PAB = PB – PA
$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
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