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An East Coast View: The Right Price for PJM

Fortnightly Magazine - October 1 1997

area. Once the LMP calculation system is set up (em it already exists at the PJM ISO (em calculating and publishing the LMP is straightforward and simple.

Does LMP cost more than a physical redispatch? No. LMP pays to generators and charges to loads the market-clearing price at their respective locations (for any purchases and sales of spot energy), while charging transmission users the difference in LMP (if any) as a congestion charge. Each LMP is based on the marginal cost of meeting load at each location.

In a competitive market, the "cost" of congestion could not effectively be limited to only the incremental physical redispatch costs of the generator or generators dispatched out of merit. All other generators in the constrained area would rationally attempt to increase their bids up to that market-clearing price. PECO's proposal ignores this latter effect and thus greatly understates even the costs of physical redispatch. In addition, the effects of congestion include not only the increased costs from bringing on higher-cost generation in constrained areas, but also the decreased cost of generation in the unconstrained areas. PECO's averaging scheme denies customers in these areas the benefits of the lower costs.

Congestion costs likely will vary significantly over time, as loads, the transmission system and market conditions change. Consequently, the choice of a congestion pricing method should turn on the merits of the method, not speculation about the size of congestion.

Does LMP bundle energy with transmission? No. LMP determines the market-clearing price of spot energy at each location. As Schweppe, et al, demonstrated, differences in spot energy prices define the transmission price (or congestion charge) between any two locations.

The FERC prohibits bundling that requires a participant to buy one product in order to buy another. However, under the proposal, market participants can purchase transmission separately without having to purchase energy from the ISO's spot market. Moreover, the proposal allows the ownership of transmission "rights" (fixed transmission rights) to be separated from the actual use (or dispatch) of the grid. That is, a trader does not have to acquire the FTRs that match its actual or expected trade. The FTRs merely define the degree of financial hedging the trader has for its trade. Other proposals (CCEM's physical rights approach) force traders to acquire the transmission rights that match their energy trades as a condition for using the grid. This "bundling" is both unnecessary and more expensive for traders, because it requires additional bilateral trading to acquire the correct rights.

Transmission use and the dispatch of generation are intrinsically inseparable. That is, defining transmission usage implicitly defines the dispatch of generation and loads at each location, and defining the dispatch of generation and loads at every location implicitly defines transmission usage.

Does LMP hinder forward and secondary markets? No. Having an efficient, spot-market clearing price at each location facilitates forward and secondary markets, because it gives market participants a transparent reference price to judge the value of such trades. Alternative proposals would eliminate or obscure these efficient price signals.

A related issue is whether defining financial hedging