In competitive power markets based on locational marginal pricing (LMP), the facts sometimes conflict with popular belief. Most notably: 1. When there’s congestion, the books don’t balance, and...
Learning to Love Congestion
Competitive market problems and their implications for customers’ net costs.
In competitive electric power markets, trades clear at market prices. Buyers (ratepayers) pay locational marginal prices (LMP), and sellers (generators) receive those prices. Because sellers and buyers all trade at the same clearing price—at least within zones that have no internal congestion—and because everything the ratepayers buy is sold by the generators, the sales books are supposed to automatically balance. Further, everyone knows that congestion reduces efficiency and raises prices, on average, and that the economic benefit to the ratepayers of reducing congestion is the net change—positive and negative—in LMP, multiplied by the energy sold to the ratepayers.
Unfortunately, when congestion occurs, the first and third of these three so-called “facts” generally are false. The second is true or false depending on where you stand—as a generator, a ratepayer, or society as a whole.
The discrepancy between what’s expected and what really happens arises from basic differences, not generally appreciated, between traditional cost-recovery markets and newer competitive market structures. These unappreciated differences have important implications for market design, tariffs, transmission planning, and system operation.
Unbalancing the Books
In LMP markets with congestion, the total payments by the ratepayers will always exceed the total payments received by the generators. The system of Figure 1 illustrates this point with a two-zone example. It’s important to note that moving to more complex examples doesn’t change the conclusions.
In the example in Figure 1, the ratepayers pay and the generators receive the LMP of the area in which they’re located. Following the logic of economic dispatch, lower priced generation is dispatched before higher-priced generation unless congestion prevents it. Though the Area A generation is less expensive than the Area B generation, the transmission link is limiting. Only 700 MW of Area B’s load can be supplied from Area A. The remaining 300 MW must come from Area B, where the generation is more expensive.
The market-clearing price in Area A is $60/MWh. The ratepayers in Area A therefore pay $60/MWh x 100 MW = $6,000/hr. The ratepayers in Area B pay $96,000/hr. Total (gross) ratepayer payments are $102,000/hr. The generators receive $48,000/hr (Area A) and $28,800/hr (Area B), totaling $76,800. This is less than what the ratepayers pay.
The $25,200/hr difference between ratepayer payments and generator revenues can be calculated directly using the formula (MW transferred) x (LMPB – LMPA). In the United States, this difference is sometimes called “congestion costs,” “congestion charges,” “fixed transmission rights (FTR) revenues,” or “value of transmission rights.” From the formula it’s clear that with congestion this imbalance always occurs. All that’s required is that the clearing prices in two areas differ because of transmission congestion and that the transfers be greater