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Playing the Pool: Can Everybody Win?

Fortnightly Magazine - March 1 1996

As electric restructuring spreads around the nation and the world, the idea of a "PoolCo" spot market (pool) gains credence. Pools already exist in England, Australia, Norway, Alberta, and Argentina. On December 20,1 the California Public Utilities Commission formally proposed a pool, called the California Power Exchange, to begin operation as of January 1, 1998. Still, questions remain.

Can a pool adequately compensate all the generators that the market needs, or provide correct price signals for market entry? To some, this question may appear trivial. After all, generators can raise prices until they receive adequate compensation, and new generators will come in if prices are high enough.

If a pool works as intended, generators will have an incentive to bid their short-run variable costs. That assumption is made here (em that generators will in fact bid at short-run variable cost. From there, examples test whether a pool can provide an adequate power supply, compensate generators fairly, and give correct signals for adding new capacity.

Bidding and Dispatch

The pool serves as a central energy clearinghouse to dispatch generation to meet load. The choice of which generation to run is accomplished by an auction in which generators compete by submitting bids. A bid takes a form such as, "I will supply 40 megawatts (Mw) so long as I can receive a price of at least $30/Mwh." The pool operator (often called the "Independent System Operator," or ISO) that manages the auction dispatches generators in order of their bids, lowest first, until load is met. All the generators that get dispatched are paid according to the bid of the last generator chosen, that being the market-clearing price for the period in question. The period would cover a single hour or perhaps half an hour. Pool proponents may envision this spot market as just one mechanism in a market that might feature bilateral contracts, options, and futures. Even so, the pool would occupy a central position, providing a reference point for the other markets.

Ideally, generators bidding into the pool would not collude, explicitly or tacitly. None of them individually would control enough of the market to hold out a reasonable expectation of setting the market-clearing price. In these circumstances, generators should try to bid as low as they can, because this strategy will best assure that they will be dispatched and operating during all hours when the market-clearing price rises high enough to yield some contribution, small or large, to fixed-cost recovery and profit. "As low as they can" would be variable cost or, for a unit that has multiple operating levels with varying efficiencies, marginal cost. Variable cost equals fuel cost plus variable operation and maintenance. Marginal cost represents the change in hourly operating cost divided by change in output, and is close or equal to variable cost when a unit is operating in its most efficient range. If all generators bid variable or marginal cost, the pool can

effectively perform one of its most important functions, economic dispatch (em i.e., meeting load with the least-cost combination of resources.

The pool could also