Pricing the Grid: Comparing Transmission Rates of the U.S. ISOs
Figure 1, that this simple power system has a generator and a load at each of the two busses, none of which exercises market power. The western generator can produce up to 1,000 MW at a constant incremental cost of $20 per megawatt-hour, while the eastern generator can produce up to 200 MW at a constant incremental cost of $21 per megawatt-hour. Western and eastern loads are 500 MW and 392 MW, respectively.
Given that losses depend upon flows, Figure 1 shows the least-cost system dispatch: The western generator produces 753J MW while the eastern generator produces 145J MW. That results in total generation costs of $18,110.
Figure 1 shows that the three pricing approaches, not surprisingly, lead to different pricing results. Marginal cost pricing leads to prices that, for both generators and consumers at each bus, equal the incremental cost of generation, including the incremental costs of losses. As planned for implementation in PJM, consumer prices for losses will vary by bus as illustrated in Figure 1. In New York, which has zonal pricing for loads, the charge for losses in each zone equals a load-weighted average of the incremental costs of the losses associated with serving load at each bus. In other words, New York uses marginal cost pricing of losses between zones, but a version of postage stamp pricing of losses within zones.
Marginal cost pricing of losses can lead to over-recovery of the costs of losses. In Figure 1, marginal cost pricing yields total consumer payments of $18,232, leading to an excess recovery of $122.[Fn.2] In New York, this excess would be used to reduce scheduling, system control and dispatch service charges by $122.
The postage stamp and scaled marginal cost approaches lead to prices that are not consistent with efficient dispatch. Under the postage stamp approach, all consumers pay a price equal to the average cost of bringing power to each consumer. In Figure 1, consumers in the West and East pay the same power price, so that consumers in the west pay for losses that they clearly do not cause, while consumers in the east pay for less than half of the losses that they do cause. But at the $20.30 price, no consumer willingly would pay $21 to the eastern generator. Instead, all consumers would make bilateral arrangements to buy power from the western generator.
The scaled marginal cost approach produces a similar result. Applying the California version to the example of Figure 1, this approach would find that the western generator is responsible for 8K MW of losses, while the eastern generator is responsible for reducing losses by 2J MW. Together, they together account for the 6G MW lost in transmission. For output actually delivered to consumers, the western generator's break-even price must exceed its $20 incremental cost by enough to cover losses, while the eastern generator, which is credited with reducing losses, would have a break-even price less than its $21 incremental cost.[Fn.3] Because consumers are not directly responsible for the costs of losses, consumer prices will tend to be the same under