Power System Economics

Designing Markets for Electricity

Ste v e n Sto f t
IEEE / Wiley

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

Cover painting by W. Louis Sonntag, Jr. (1869-1898), The Bowery at Night, c. 1895. Early deregulated electricity market with trolleys powered by Westinghouses AC and shops probably illuminated with Edisons DC. The houses may still be lit by gas. The Third Avenue Elevated (1878), whose noise and shadows contributed to the decline of New Yorks onceelegant theater district, will soon be electrified. (Uncle Toms Cabin was first staged in the Bowery Theatre visible at the extreme left.) Arc lights, brought to New York streets in 1880 by Charles Brush, transformed night life. Sonntag frequently depicted the resulting sense of glamour and excitement. The watercolor was a Gift of Mrs. William B. Miles to the Museum of the City of New York.

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

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

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

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

Contents in Brief
List of Results and Fallacies Preface Acronyms and Abbreviations Symbols xiv xviii xx xxii

Part 1. Power Market Fundamentals

Prologue Why Deregulate? What to Deregulate Pricing Power, Energy, and Capacity Power Supply and Demand 2 6 17 30 40 What Is Competition? Marginal Cost in a Power Market Market Structure Market Architecture Designing and Testing Market Rules 49 60 74 82 93

Part 2. Reliability, Price Spikes and Investment

Reliability and Investment Policy Price Spikes Recover Fixed Costs Reliability and Generation Limiting the Price Spikes Value-of-Lost-Load Pricing 108 120 133 140 154 Operating-Reserve Pricing Market Dynamics and the Profit Function Requirements for Installed Capacity Inter-System Competition for Reliability Unsolved Problems 165 174 180 188 194

Part 3. Market Architecture

Introduction The Two-Settlement System Day-Ahead Market Designs Ancillary Services The Day-Ahead Market in Theory 202 208 217 232 243 The Real-Time Market in Theory The Day-Ahead Market in Practice The Real-Time Market in Practice The New Unit-Commitment Problem The Market for Operating Reserves 254 264 272 289 306

Part 4. Market Power

Defining Market Power Exercising Market Power Modeling Market Power 316 329 337 Designing to Reduce Market Power Predicting Market Power Monitoring Market Power 345 356 365

Part 5. Locational Pricing

Power Transmission and Losses Physical Transmission Limits Congestion Pricing Fundamentals Congestion Pricing Methods Congestion Pricing Fallacies Glossary References Index 374 382 389 395 404 Refunds and Taxes Pricing Losses on Lines Pricing Losses at Nodes Transmission Rights 411 417 424 431

443 455 460

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

Contents

List of Results and Fallacies Preface Acronyms and Abbreviations Symbols

xiv xviii xx xxii

Part 1. Power Market Fundamentals

Prologue
Reading to Different Depths Reading Out of Order 4 3

1-1

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

1-2

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

17

1-3

Pricing Power, Energy, and Capacity

Measuring Power and Energy 32 Measuring Generation Capacity 33 Pricing Generation Capacity 33 Technical Supplement 39

30

1-4

Power Supply and Demand

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

40

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

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1-5

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

49

1-6

Marginal Cost in a Power Market

The Role of Marginal Cost 62 Marginal-Cost Fallacies 63 The Definition of Marginal Cost 65 Marginal Cost Results 67 Working with Marginal Costs 69 Scarcity Rent 70

60

1-7

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

74

1-8

Market Architecture
Listing the Submarkets 84 Market Types: Bilateral through Pools Market Linkages 89 86

82

1-9

Designing and Testing Market Rules

Design for Competitive Prices 95 Design to Prevent Gaming 98 Auctions 99 Testing a Market Design 101 Technical Supplement: Example of a Bottom-Line Test

93

103

Part 2. Reliability, Price Spikes, and Investment

2-1 Reliability and Investment Policy
Price Regulation is Essential 111 The Profit Function 114 Side Effects of Reliability Policy 116 Inter-System Competition 117 Demand-Side Effects of Price Limits 118

108

2-2

Price Spikes Recover Fixed Costs

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

120

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

Contents

2-3

Reliability and Generation

Operating Reserves and Contingencies 134 Adequacy and Security 135 The Simple Model of Reliability 136 The Fundamental Reliability Question 139

133

2-4

Limiting the Price Spikes

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

140

2-5

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

154

2-6

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

165

2-7

Market Dynamics and the Profit Function

Calculating Profit Functions 175 Interpreting the Profit Function 177

174

2-8

Requirements for Installed Capacity

The Capacity-Requirement Approach 181 Short-Run Profits with a Capacity Requirement 182 Combining a Capacity Requirement with a Price Spike Comparing the Two Approaches 186 184

180

2-9

Inter-System Competition for Reliability

Price-Cap Competition 189 Competition between Price Spikes and Capacity Requirements

188
191

2-10 Unsolved Problems

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

194

Part 3. Market Architecture

3-1 Introduction
Spot Markets, Forward Markets and Settlements Architectural Controversies 204 Simplified Locational Pricing 206 203

202

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

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3-2

The Two-Settlement System

The Two-Settlement System 209 Ex-Post Prices: The Traders Complaint 214

208

3-3

Day-Ahead Market Designs

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

217

3-4

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

232

3-5

The Day-Ahead Market in Theory

Equilibrium Without a Clearing Price 244 Difficulties with Bilateral Day-Ahead Markets Settlement, Hedging, and Reliability 250 Other Design Considerations 252 247

243

3-6

The Real-Time Market in Theory

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

254

3-7

The Day-Ahead Market in Practice

Arbitrage vs. Computation 265 Efficiency 268 Reliability and Control 269 Risk Management 270

264

3-8

The Real-Time Market in Practice

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

272

3-9

The New Unit-Commitment Problem

How Big Is the Unit-commitment problem? 291 Unit Commitment in a Power Exchange 294 Investment Under a Power Pool 302

289

3-10 The Market for Operating Reserves

Types of Operating Reserve 307 Scoring by Expected Cost 309 Scoring Based on the Capacity Bid Only Opportunity-Cost Pricing 313 310

306

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

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Contents

Part 4. Market Power

4-1 Defining Market Power
Defining Market Power 318 Defining Price-Quantity Outcomes 319 Three Stages of Market Power 321 Using Price-Quantity Outcomes to Show Market Power Monopoly Power in a Power Auction 326 Market Power on the Demand Side 327

316

323

4-2

Exercising Market Power

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

329

4-3

Modeling Market Power

Monopoly and the Lerner Index 338 The Cournot Model 340 Unilateral Action and the HHI 342 Technical Supplement: Markup Determination

337

343

4-4

Designing to Reduce Market Power

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

345

4-5

Predicting Market Power

Four Factors that HHI Ignores 357 Why the Lerner Index Is Unreliable 358 Estimating Market Power 361 Technical Supplement: Market Power and Forward Contracts

356

363

4-6

Monitoring Market Power

FERCs Ambiguous Standard Market Monitoring 368 366

365

Part 5. Locational Pricing

5-1 Power Transmission and Losses
DC Power Lines AC Power Lines 375 378

374

5-2

Physical Transmission Limits

Thermal Limits on Power Lines 383 Reactive Power and Thermal Limits 384 Stability Limits on Power Lines 386

382

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

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5-3

Congestion Pricing Fundamentals

Congestion Pricing Is Competitive Pricing Benefits of Competitive Locational Prices 390 393

389

5-4

Congestion Pricing Methods

Centralized Computation of CLPs 396 Bilateral Pricing Compared to Centralized Pricing 399

395

5-5

Congestion Pricing Fallacies

Are Competitive Locational Prices Too High? Congestion Taxing 408 404

404

5-6

Refunds and Taxes

Pricing Versus Taxing Energy Taxes 414 412

411

5-7

Pricing Losses on Lines

The Competitive Price is Twice the Average Cost Competitive Losses Pricing 419 Inefficiency of Average-Cost Loss Pricing 421 418

417

5-8

Pricing Losses at Nodes

Nodal Loss Prices 425 Full Nodal Pricing: Loss, Congestion and Reference Prices Three Common Restrictions on Losses Pricing 429 427

424

5-9

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

431

Glossary References Index

443 455 460

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

List of Results and Fallacies

1 2 3 4 5 6 7 8 9
The Efficient-Competition Result The Marginal-Cost Pricing Result The Marginal-Cost Fallacy The Ambiguous-Price Fallacy The System-Marginal-Cost Pricing Result The Fixed-Cost Fallacy The Weak Fixed-Cost Fallacy The Reliability Fallacy The Regulatory-Price-Spike Result

10 11 12 13 14 15 16 17 18

The Price-Cap Result The Contracts-for-Differences Result 1 The Contracts-for-Differences Result 2 The Efficient-Auction Result The HHI Result The Market-Power Fallacy Locational-Pricing Result 1 Locational-Pricing Result 2 The Locational-Pricing Fallacy

Part 1. Power Market Fundamentals

Why Deregulate?

Result

1-1.1 1-3.1 1-3.2 1-4.1 1-5.1 1-5.2 1-5.3a 1-5.3b 1-5.3c 1-6.1 1-6.2 1-6.1 1-6.2 1-6.3 1-8.1 1-9.1 1-9.1 1-9.2 1-9.3 1-9.4

Savings from Real-Time Rates Would Be Small Fixed and Variable Costs Are Measured in Different Units Energy, Power, and Capacity Are Priced in $/MWh Supply Equals Consumption but May Not Equal Demand Competitive Prices Are Short- and Long-Run Efficient Competitive Suppliers Set Output So That MC = P Under Competition, Average Economic Profit Is Zero Under Competition, Fixed Costs Are Covered A Supplier with a Unique Advantage Can Do Better Marginal Cost Equals the Cost of the Last Unit Produced When Marginal Cost Is Ambiguous, so Is the Competitive Price Competitive Suppliers Set Output so MCLH < P< MCRH Competitive Price Equals System Marginal Cost Supply Intersects Demand at the Competitive Price The Forward Price Is the Expected Future Spot Price Scarcity Rents Are Unfair Changing the Markets Rules Changes Behavior Design Market Mechanisms to Induce Truth Telling Four Types of Auctions Produce the Same Revenue A Vickrey Auction Is Incentive Compatible

14 34 36 48 54 57 58 58 58 64 65 68 69 90 95 97 99 100 100

Pricing Power, Energy, and Capacity

Fallacy
Result Result

Power Supply and Demand What Is Competition?

1 2

Result Result Result Result Result

Marginal Cost in a Power Market

3 4 5

Fallacy Fallacy
Result Result Result Result

Market Architecture Designing and Testing Market Rules

Fallacy
Result Result Result Result

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

List of Results and Fallacies

xv

Part 2. Reliability, Price Spikes, and Investment

Price Spikes Recover Fixed Costs

6 7

Fallacy
Result Result

Fallacy
Result Result Result Result Result Result

2-2.1 2-2.1 2-2.2 2-2.2 2-2.3 2-2.4 2-3.1 2-4.1 2-4.2 2-4.3 2-4.1 2-4.4 2-4.5 2-4.6 2-4.7 2-4.8 2-5.1 2-5.1 2-5.2 2-5.2 2-6.1 2-6.2 2-6.3 2-6.4 2-7.1 2-7.2 2-8.1 2-8.2 2-8.3 2-8.4 2-9.1 2-9.2 2-9.3 2-10.1

Marginal-Cost Prices Will Not Cover Fixed Cost In the Long-Run, Suppliers Recover Their Fixed Costs Long-Run Equilibrium Conditions for Two Technologies Marginal-Cost Pricing Causes a Capacity Shortage Marginal-Cost Prices Induce the Optimal Mix of Technologies Inefficiency Caused by the Lumpiness of Generators Is Negligible
* = FC ' V Optimal Duration of Load Shedding Is DLS peak LL

121 123 128 129 129 131 139 143 145 147 111, 147 114, 147 150 113, 152 152 153 156 159 159 161 116, 168 169 171 117, 173 177 178 115, 181 184 185 186

Reliability and Generation

Limiting the Systems Price

8 9

Fallacy

Result Result 10 Result Result Result

A Small Amount of Elastic Demand Can Make the Market Efficient Too Little Demand Elasticity Can Cause the Real-Time Market to Fail Suppressing the System Operators Balancing Market Is Inefficient The Market Will Provide Adequate Reliability Regulatory Policy Determines the Height and Duration of Price Spikes Do Not Cap Prices at the Highest Demand Bid The Real-Time Price Limit Effectively Caps the Entire Market Conditions for the Failure of a Power Market Conditions for an Efficient Power Market VOLL Cannot Be Usefully Defined Within the Simple Model of Reliability, VOLL Pricing Is Optimal Inaccuracy of Estimation Does Not Rule Out the Use of VOLL Risk from VOLL Pricing Is Beneficial Many Different Price Limits Can Induce Optimal Investment A Lower, Longer-Duration Aggregate Price Spike Is Less Risky High Price Caps Invite the Exercise of Market Power Reliability Policy Should Consider Risk and Market Power The Higher the Price Spikes, the Steeper the Profit Function Steeper Profit Functions Increase Risk and Market Power Energy and Capacity Prices Together Induce Investment A Capacity Requirement Can Eliminate the Need for Price Spikes VOLL Pricing Induces Optimal ICap Even When ICap Is Random Profit Functions Are Additive, But Resulting Profits Are Not

Value-of-Lost-Load Pricing

Fallacy
Result Result

Fallacy
Result Result Result Result Result Result Result Result Result Result Result Result Result Result

Operating-Reserve Pricing

Market Dynamics and the Profit Function

Requirements for Installed Capacity

Inter-System Competition for Reliability

Competition Between System Operators Induces High Price Spikes 118, 190 Trading between Markets with Different Policies Can Reduce Reliability 191 Capacity-Requirement Markets Need Annual Requirements 192 The Price of Operating Reserves Should Increase When They Are Scarce 198

Unsolved Problems

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

xvi

List of Results and Fallacies

Part 3. Market Architecture

The Two-Settlement System

Result 11 Result 12 Result

3-2.1 3-2.2 3-2.2 3-3.1 3-4.1 3-5.1 3-5.2 3-6.1 3-6.2 3-7.1 3-8.1 3-8.2 3-9.1 3-9.2 3-9.3 3-9.4 3-9.5 3-9.6 3-9.7

A Two-Settlement System Preserves Real-Time Incentives A Contract for Differences Insulates Traders from Spot Price Volatility Contracts for Differences Preserve Real-Time Incentives A Single-Price Day-Ahead Auction Is Efficient Strictly Bilateral Power Trading Requires Centralized Coordination A Bilateral DA Market Decreases Reliability Side-Payments in a Day-Ahead Pool Do Not Increase Reliability Real-Time Power Is Not Bought or Sold Under Contract Real-Time Pools Sometimes Require Direct Control of Generation A Day-Ahead Power Pool Is Not Required for Reliability SMC Unit Commitment with Elastic Demand Is Inefficient System-Marginal-Value Pricing Provides Efficient Demand Incentives A Power Exchanges Unit-Commitment Inefficiency Is Less Than 1%. Marginal Cost Prices Can Solve Some Unit-Commitment Problems A Power Exchange Lacks a Classic Competitive Equilibrium A Power Pool with Accurate Bids Induces the Optimal Dispatch Two-Part Bids Can Solve Some Unit-Commitment Problems A Power Exchange Has a Nearly-Efficient Nash Equilibrium Side Payments in Power Pools Distort Investment in Generation

210 212 213 220 241 249 252 256 259 269 283 284 293 294 297 297 298 300 303

Day-Ahead Market Designs

13 Result
Result Result Result Result Result Result Result Result Result Result Result Result Result Result Result Result

Ancillary Services The Day-Ahead Market in Theory

The Real-Time Market in Theory

The Day-Ahead Market in Practice The Real-Time Market in Practice

The New Unit-Commitment Problem

The Market for Operating Reserves

3-10.1 Capacity-Bid Scoring for Spinning Reserves Is Optimal

Part 4. Market Power

Defining Market Power

Result Result Result Result Result

4-1.1 4-1.2 4-1.3 4-2.1 4-2.2 4-3.1 4-5.1 4-6.1 4-6.2

Monopoly Power Always Causes the Quantity Withheld to be Positive When Assessing Monopoly Power, Ignore Demand-Side Flaws Profitably Raising the Market Price May Not Be Market Power Market Power Cannot Be Exercised in Day-Ahead Power Markets The Bid that Raises the Price May Not Set the Price The Average Lerner Index Equals HHI Over Demand Elasticity Price Distortion Measures Market Power Better Some Market Power Is Needed and Beneficial Market Power Cannot Be Proven

325 325 326 331 332 342 361 370 370

Exercising Market Power

Modeling Market Power

14 Result
Result

Predicting Market Power Monitoring Market Power

15 Fallacy Fallacy

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

List of Results and Fallacies

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Part 5. Basic Locational Pricing

Power Transmission and Losses

Result Result Result Result Result Result 16 Result Result 17 Result

5-1.1 5-1.2 5-1.3 5-1.4 5-2.1 5-3.1 5-3.2 5-4.1 5-4.2 5-5.1 5-6.1 5-6.2 5-6.3 5-6.4 5-7.1 5-7.2 5-7.3 5-7.4 5-8.1 5-8.2 5-9.1 5-9.2 5-9.3

Kirchhoffs Laws Power Equals Voltage Times Current (Volts Amps) Ohms Law Is Voltage Equals Current Times Resistance (I R ) Transmission Losses Are Proportional to Power2 / Voltage2 Thermal Limits Depend on Real and Reactive Power Flows Transmission Price AB Is the Power Price Difference, PB ! PA Only Competitive Locational Prices Minimize Total Production Cost

376 377 377 378 385 392 394 397 401 406 414 414 415 416 418 419 421 423 427 427 433 439 440

Physical Transmission Limits Congestion Pricing Fundamentals

Congestion Pricing Methods

Power Flows Are Approximately Additive Competitive Bilateral Prices Equal Centralized Locational Prices Congestion Rent > Redispatch Cost Is Unfair to Consumers Price for Efficiency and Not to Raise Revenue Tax for Revenue and Not to Improve Efficiency An Energy-Based Transfer from Generators to Loads has No Net Effect An Energy Tax on Load or Generation Will Be Paid by Load Marginal Losses Are Twice Average Losses The Competitive Charge for Transmission Is Twice the Cost of Losses Competitive Bilateral Loss Prices Equal Marginal Cost Average-Cost Loss Pricing Raises the Cost of Production Changing the Reference Bus Changes Loss Prices Uniformly Changing the Reference Bus Does Not Affect Bilateral Trades Trading Opportunities Are Not Blocked by Congested Lines Revenue from a Feasible Set of TCCs Will Be Sufficient The Feasible Set of Physical Rights Cannot Account for Counterflows

Congestion Pricing Fallacies

18 Fallacy
Result Result Result Result Result Result Result Result Result Result Result Result Result

Refunds and Taxes

Pricing Losses on Lines

Pricing Losses at Nodes

Transmission Rights

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

Preface

My original purpose in writing this book was to collect and present the basic economics and engineering used to design power markets. My hope was to dispel myths 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 present on two key issues: price-spikes and pools. While the majority of the book still holds to my first purpose, Parts 2 and 3 are guided as well by a second. They seek to present the two unresolved issues coherently, answer a few basic questions and highlight some of the gaps in our current understanding. The price-spike issue is how to design the market to accommodate two demandside flaws underlying the price-spikes that provide incentives for investment in generation. Part 2 shows that some regulation is required until one flaw has been mitigated. The first regulatory goal should be to ensure the revenue from the aggregate price spike is just sufficient to induce a reliable level of generating capacity. This revenue is determine by (1) the duration of the aggregate price spike which is under the influence of NERC guidelines and (2) the height of the price spike which is regulated by FERC. Currently, neither institution appears aware their policies jointly determine investment. Part 2 provides a framework for computing the level of investment induced by any combination of NERC and FERC policies. Because many combinations will work, it suggests a second goal. Price volatility should be reduced to levels that might be expected from a mature power marketlevels far below those observed in the current markets with their incapacitated demand sides. I hope Part 2 will clarify the regulatory options and the need to fix the markets demand side. While Part 3 presents the standard principles of bilateral markets, exchanges and pools, it is able to make little progress on the second issue, the power-pool question. An exchange is a widely used form of centralized marketthe New York Stock Exchange is an examplewhile pools are peculiar to power markets. Exchanges trade at one price at any given time and location, while pools pay different prices to different generators according to their costs. The differences in transparency 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 issues and show the answers are far from obvious. While three pools operate in the eastern U.S. and PJM has been deregulated for nearly four years, no evaluation of their efficiency has been undertaken. The only national effort, a shoestring operation at the Department of Energy, has been crippled 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 evaluate the performance of pools or their potential benefits. No description of any eastern

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

Preface

xix

pool, suitable for economic analysis, can be found within FERC or in the public domain. Theoretical pool descriptions cover ex-ante pricing while knowledgeable observers indicate the eastern ISOs use ex-post pricing. This is said to be based on a philosophy of controlling quantities in real-time and computing prices after the fact. In practice, it involves proprietary calculations that apparently assume the operators actions were optimal. I could discover no useful discussion of the theory of this critical issue, so readers of Part 3 must wait for a later edition. Competitive power markets, like regulated markets, must be designed and designed well. Because of the poor quality of many current designs and the lack of a well-tested standard, this book does not recommend a rush to deregulate. A given deregulation may succeed, but economic theory cannot predict when such a complex political process, once begun, will be out-maneuvered by the forces it seeks to harness. If a market is being designed or redesigned, this book is meant to 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 invaluable service and deserve thanks from all of my readers, whom they have protected from many confusions, diversions, and errors. For this difficult undertaking I am especially grateful to Ross Baldick, Joe Bowring, Haru Connally, Rob Gramlich, Doug Hale, 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 fresh views and caught errors. Thanks to Darwin Anwar, Gerry Basten, Richard Benjamin, Severin Borenstein, Jason Christian, Ed Mills, Udi Helman, Mike Rothkopf, Erik Hirst, Ben Hobbs, Mangesh Hoskote, Marcelino Madrigal, Dave Mead, 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, Tony Vengraitis, and Andrew Prince, none of this would have been possible. My copy editor, Susan Ingrao, has been a pleasure to work with and tremendously informative, even answering arcane typesetting questions. Remaining errors are the result of my inaccurate corrections or last minute changes. For support and guidance on every challenge, I have turned first to my wife Pamela who has been my creative advisor, editor, and legal counsel. I thank her for 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. Through three complete drafts, she gently but persistently corrected and shaped, guided and polished. While the quality of my writing still falls far short of my mothers, it delights me to have learned, at last, a little of her art.

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

Acronyms and Abbreviations

AC ACE CA ISO CFD CLP CR DA DOJ FERC FTR FTC GT HHI ICap IPP ISO ISO-NE LBMP LHMC LMP LRMC MC NERC NYISO NYSE NE OpRes PJM PTR RHMC RT RTO SMC SMV TR UC VOLL alternating current area control error California Independent System Operator contract for differences competitive locational price capacity requirement day ahead Department of Justice Federal Energy Regulatory Commission financial transmission right Federal Trade Commission gas turbine generator Herfindahl-Hirschman index installed capacity independent power producer independent system operator ISO New England locational-based marginal price left-hand marginal cost locational marginal price long-run marginal cost marginal cost North American Electric Reliability Council the New York Independent System Operator, Inc. the New York Stock Exchange Nash equilibrium operating reserve Pennsylvania-New-Jersey-Maryland Independent System Operator physical transmission right right-hand marginal cost real time (market) regional transmission organization system marginal cost system marginal value transmission right unit commitment value of lost load

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

Acronyms and Abbreviations

xxi

Units Used to Measure Electricity V volt The unit of electrical pressure A amp The unit of electrical current W watt Power (Energy per hour) h hour Time Wh watt-hour Energy k 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.

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

Symbols

Units

Symbol
e
peak

Definition
*

, ,

equilibrium and optimal superscripts peakload, intermediate, and baseload generating capacity subscripts day-ahead, and real-time subscripts bus-A, bus-B subscripts

mid

,
1 A

base 0 B

$/MWh $/MWh $/MWyear $/MWh none none none none none none MWh $/MWh $/MWh MW none none amps MW MW

ACE ACK ARR CC cf C DLS DPS Dpeaker e E FC FT g h ^ h I K K

average cost of energy for a load slice average cost of purchasing and using capacity for a load slice annual revenue requirement of a generator cost of providing spinning-reserve capacity. capacity factor cost of Production duration of load shedding duration of price spike duration of peaker use price elasticity of demand energy fixed cost current price of a future for delivery at time T generation out of service true probability of needing spinning reserves estimated h electrical current installed generating capacity (ICap) average K in an equilibrium when K is random. (Lg > K ) (Lg + ORR > K ) (Lg + ORR > Kbase )

ne

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

2 Pages of Symbols Missing

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