To what extent should the independent system operator (ISO) and the spot market (Power Exchange) remain separate? Thinking about how the ISO must operate leads to certain conclusions.
Of necessity, the ISO will operate a noncontract market. That is, the ISO will match some supply and some demand that are not covered by generator-customer contracts. If we want the ISO to operate at least cost, it must acquire at least part of its supply by soliciting hourly offers from generators, producing what amounts to a supply-side spot market. Then, it must charge a variable hourly rate for balancing energy that tracks the supply-side variations in cost. This two-fold process produces a market-clearing price (em a price that balances supply and demand. The issue of "separation" is really a question of access: Whether we will allow all generators and customers to participate in the ISO's spot market (em or require them to trade through a separate spot market called the "Power Exchange." Consumers receive no benefit if they are excluded from the ISO's spot market. Moreover, broader participation will make the ISO's job easier and more efficient.
Balancing Load
The ISO's basic job is load balancing. To match aggregate load and supply, the ISO must be able to increase or decrease the output of certain generators to offset the aggregate imbalance of all contractual arrangements. To offset positive imbalances (contract generation greater than contract load), the ISO must hold some dispatchable capacity at all times, producing power that can be backed down.
But where does this noncontract supply go when all contractual supply and demand achieve balance? The answer: The ISO must also hold some noncontract load that it supplies at all times. In short, to balance the overall market, the ISO must itself act as a sort of aggregator, with its own supply and load. The net imbalance in the ISO's market will offset the net imbalance in the rest of the market.
Some proposals seem to envision the ISO taking supply from a designated set of contract generators. But if the ISO is to operate as cost-effectively as possible, it is not sensible to acquire all of the balancing supply from contracts with specific generators. For at least part of its supply, the ISO should be able to solicit offers on an hourly basis from any generator, and choose (i.e., dispatch) the cheapest offers that meet its needs. Some of these offers might take the form of demand-side bids to reduce load, which can also be provided hourly. The result finds the ISO operating what amounts to an hourly spot market.
Clearing the Market
We do not want the ISO "buying" and "selling" power for a profit. Therefore, the price the ISO charges its customers (e.g., consumers with negative imbalances) for energy should equal the price the ISO pays for its balancing energy.
In a competitive market, we want decisions driven by market factors, not by regulation. That means the supply acquired by the ISO should be priced by the market; generators should remain free to ask whatever price they want for energy supplied to the ISO. Moreover, the ISO should rely as much as possible on price signals to achieve load balancing. The ISO can rely on price to balance load by setting the hourly balancing charge equal to the marginal cost paid to the generators that provide the balancing energy. Therefore, the ISO's prices for energy supplied (e.g., for negative imbalances) should not be set by regulation, but by whatever price generators are asking for additional supply (or whatever prices customers are bidding in for load reductions). This model makes the ISO's rate for balancing energy a true real-time pricing (RTP) rate.1 In short, the ISO can keep load and supply in balance through an hourly energy cost set by the market. Administrative decisions or "penalty" pricing become unnecessary.
There is no reason to exclude any customer or generator that wishes to participate in the ISO spot market. Quite the opposite; the more players who participate, the more efficient is the ISO, which gains flexibility in balancing supply and demand with an increase in the number of generators and customers who offer supply and price-responsive load.2 Similarly, as more supply becomes available, the cost may fall for energy used for balancing. Finally, the larger the spot market, the more price-responsive load.
Financial Settlements
The ISO actually performs two functions, one physical (or operational) and one financial. First, the ISO physically balances kilowatt-hour supply and load every instant for the overall system.3 Second, at the end of the day (or week or month), the ISO balances the dollars. These two tasks represent separate functions and, in fact, can prove quite different. For physical balancing, the ISO need know nothing about contracts (em that is, which generator serves which customer.4 Generator G1 may be serving Customer Cg and Generator G5 serving Customer Cb. As far as the ISO and its operations are concerned, the contractual pairing could be G1:Cb and G5:Cg. It simply doesn't matter. For financial balancing, on the other hand, the ISO must know the kilowatt-hour obligation and entitlement amounts of every "direct pay" contract,5 in order to track the generation/usage balance between each generator (or aggregator) and its customers.
To illustrate the difference, imagine that in a given hour all contracts between generators and
customers are perfectly in balance, except for two. In one of those contracts, the generator produces 10 kilowatt-hours (Kwh) more than the customer takes; in the other, the generator produces 10 Kwh less than the customer takes. From a physical perspective, the system is in balance, so the ISO has no balancing to do. However, several hours (or days) later, after all the meters are read, the ISO discovers that one contract (or generator) had a positive imbalance and the other contract (or generator) had a negative imbalance. The ISO accounting office must then charge the generator who had the negative imbalance, and pay the generator who had the positive imbalance. Thus, the ISO did not have to do any physical balancing for that hour, only financial balancing. In fact, even if every contract were out of balance, the system would still balance. The same would hold true if three (or 30) contracts were out of balance but offset each other (em financial balancing with no physical balancing.
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The issue is not whether the ISO should operate a spot market. To perform load balancing, the ISO must have supply and load, with net imbalance between the two representing the amount needed to offset the net imbalance in the rest of the market. To perform load balancing at least cost, the ISO must be able to choose the cheapest resources to accomplish that function.
What's in question is whether we want to let others participate in that spot market. The ISO produces a market-clearing price through its basic load balancing function. Barring customers (generators or consumers) from participating in that ISO spot-market price is both unnecessary and inefficient. t
Mark Drazen is president of Drazen Consulting Group in St. Louis, MO. He was a member of the Alberta Department of Energy Technical Group that helped introduce a restructured electric utility industry in Alberta (with an independent power pool) on January 1, 1996.
1. In most current electric systems, customers do not face increased cost when the system gets tight. Because most rates are fixed, customers have neither the information nor the incentive to reduce load when incremental supply becomes more expensive. Time-of-use (TOU) pricing attempts to remedy this to some extent, but TOU prices are set ex ante and usually specified for fixed time periods. They do not reflect actual system conditions or costs at any given hour. RTP improves the timing of the signals. However, RTP energy rates are usually tied to system lambdas which, in turn, reflect incremental running costs,but not capacity costs. Capacity costs can be simulated by hourly adders, but these do not necessarily reflect the actual cost of incremental supply. Moreover, some independent generators might be willing to provide extra supply if they were paid the hourly kilowatt-hour rates reflected in the RTP rates, but this option is not available. Thus, although RTP rates are an improvement, they remain a crude approximation of a true market-clearing price.
2. The broader and deeper the market (on both supply and demand sides), the less the ISO actually has to do balance supply and demand; price signals will motivate generators and consumers.
3. To keep supply and demand in balance, the ISO chooses the cheapest generation resources and requests them to provide energy.
4. For example, the New England Power Exchange dispatches plants for load balancing without regard to ownership.
5. Under a "direct pay" contract, the customer pays the generator directly for the kilowatt-hours supplied. The ISO must determine how many (if any) kilowatt-hours used by the customer cam from ISO supply--and charge the customers (or its generator) accordingly. On the other hand, if a generator and customer trade everything "though the spot market" and settle price by a contract for differences, the ISO remains indifferent to that contract. Contractual imbalance becomes irrelevant since the ISO is paid by the consumer for all kilowatt-hours used.
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