The LMP Model: Bottlenecking Merchant Transmission
Locational marginal pricing has not been adequate in providing transmission expansion incentives. Others are needed.
With the controversy created by the inclusion of locational marginal pricing (LMP) and a two- settlement system as part of FERC's standard market design (SMD), many questions have been raised about the market rules and procedures needed to support transmission infrastructure improvements, including transmission expansion. Noting that little, if any, transmission expansion beyond direct generation interconnection has occurred in the regions using LMP, some have questioned the ability of the current LMP systems to provide effective transmission expansion incentives.
In the markets in the Northeast, where LMP has been in place and sending regular price signals to market participants, there is forward movement and progress on developing some of the necessary market mechanisms to support structural remedies for congestion; however, much more remains to be done to ensure the viability of structural solutions.
While the development of unforced capacity deliverability rights (UDRs) 1 is a step forward in providing the correct incentives for merchant transmission, it remains unclear whether these and other existing incentives will be sufficient to ensure that necessary economic improvements to the transmission system will be undertaken.
Supporting the development of transmission infrastructure requires more than simply installing wire. In a market-based system, it is vital that the underlying market rules send the correct economic signals for both the use and expansion of that transmission system. Structural solutions to congestion require market rules and procedures that promote the economic use and expansion of the transmission system. These market mechanisms must apply to transmission expansions connecting multiple regional transmission organizations (RTOs) or independent system operators (ISOs), as well as those located entirely within an RTO, and should focus on the benefits created by transmission expansion.
Capacity Benefits of Transmission Expansion
Early ISO development and implementation focused on jump-starting the day-ahead and real-time LMP markets, with additional effort focused on developing market-based ancillary services and capacity markets. Ensuring that sufficient market mechanisms were in place to provide incentives for economic improvement to the grid was not at the top of the agenda. Figuring out how to integrate merchant transmission into the market, especially when the new transmission interconnected two adjoining ISOs, was further down the list. While the Northeastern ISOs cooperatively broke the ground in the United States in implementing LMP, the success of LMP on a regional and national level requires workable mechanisms to ensure both economic and reliability improvements to the grid.
In addition to serving energy needs, one of the features of transmission expansion is that it allows more capacity located at a distance from the load to be delivered to that load. This incremental ability both changes the price and quantity of energy that can reach that load, and it also contributes to the reliability of meeting that load.
Transmission expansion can make a significant contribution to meeting local reliability requirements if market rules are structured to send the correct price signals to market participants that expand the system. Market rules governing transmission expansion should include the award of capacity deliverability in