POWER SYSTEM ECONOMICS

By Chenye Wu

THIS COURSE

• Key differences between electricity market and most commodity markets;

• Why designing an effective electricity market difficult?• What are opportunities for market participants to

manipulate?• Why deregulated electricity markets may need more

regulation than the regulated one?• Operation of power system and electricity market;

• What is the role of transmission and distribution network?• What is locational marginal price?• How can different financial instruments help the market?

SYLLABUS• Week 1 Introduction• Week 2-3 Revisit of AC power flow, DC approximation,

shift factor matrix, locational marginal price• Week 4-5 Gaming opportunities, VCG implementation• Week 6-8 Unit commitment, eLMP, convex hull pricing• Week 9 Midterm• Week 10-11 Financial Instrument 1: Virtual Bidding in PJM• Week 12-13 Financial Instrument 2: FTRs• Week 14 Ancillary services• Week 15 Market power monitoring in electricity market• Week 16 Final project presentation

REFERENCE

• Steven Soft, Power System Economics – Designing markets for Electricity, Wiley, 2002

• Daniel Kirschen, Goran Strbac, Fundamentals of Power System Economics, Wiley, 2004

• Ross Baldic, Lecture notes on electricity markets, UT Austin

THIS LECTURE

• Key flaws / historical reasons that prevent us from designing an efficient market.

• Possible opportunities for the future electricity market.

100 YEARS AGO…

• By September [1897] a little building at Fourth and Market was completed and two tiny Brush arc-light dynamos were installed. Together they could supply 21lights. Customers were lured by the unabashed offer of service from sundown to midnight (Sundays and holidays excluded) for $10 per lamp per week. Yet in light-hungry San Francisco, customers came clamoring. By the first of the next year, for more generators with capacity of more than 100 lights had been added. Electricity had come to the West!

Pacific Gas and Electric – Our History

THERE WAS COMPETITION

• Between 1887 and 1893, 24 central station power companies were established within Chicago alone. With overlapping distribution lines, competition for customers were fierce and costs were high.

• Solution: acquiring a monopoly over all central station.

• Rationale: electricity business was a ‘natural monopoly’.

NATURAL MONOPOLY

• In 1898, Samuel Insull, president of the National Electric Light Association, explained

• Electricity business was a natural monopoly;• It should be regulated at the state level, instead of

local level.

• Exclusive franchises should be coupled with the conditions of public control, requiring all charges for services fixed by public bodies to be based on cost plus a reasonable profit.

IT IS TRUE, BUT

• On the scale of isolated city, provision of electricity is a natural monopoly and requires regulations, but as transmission technology developed, it brought new possibility for trade and competition.

• Moreover, by operating at extremely high voltages, the system is able to move power over great distances with very little loss, often less than three percent in a thousand miles.

• Therefore, eventually, the entire Eastern US and Eastern Canada are united in a single synchronized AC system.

DEREGULATIONS AFTER 1993

• After 10 years of operation, the British market has declared itself a failure and replaced all market rules.

• In a single year, the California market managed to cost its customers more than ten years of hoped-for savings.

• Alberta (Canada) is worried over the results of its recent auction of generation rights that brought in much less revenue than planned.

• New York saw price spikes over $6,000/MWh in 2000, and the New England ISO had to close its installed capacity market due to extreme problems with market power.

What are the fundamental problems in Deregulation?

GOAL OF REGULATION

• Deregulation is not equivalent to perfect competitionwhich is well known to be efficient.

• Electricity markets have their own inefficiencies that need to be compared with the inefficiencies of regulation.

• Opinion 1: Regulation is essential because electricity is a basic need.

• Opinion 2: Competition provides incentives to reduce costs, while regulation does not.

REGULATOR’S DILEMMA

• Regulation’s fundamental problems:• It cannot provide a strong incentive to suppliers as

cheaply as can a competitive market;• Regulatory bodies themselves do not have proper

incentives.• Truly competitive markets could provide incentives to

hold price down to the marginal cost, while minimizing cost.

• Modern theory of regulation:• Extreme 1: perfect cost of service regulation.• Extreme 2: perfect price-cap regulation.

RIGHTS OF POWER USAGE

• For most commodities• Demand is elastic. Consumption is not continuous.

• Electricity• Rights of power usage – human rights• A load should be able to “take power from the grid

without a prior contract with a generator” (FREC 2001b)

• Electricity demand can be inelastic (little incentive to be elastic). Consumption happens within a tenth of a second.

IMPLICATION

• Uncontrolled load factor (average load over peak load)• Today’s load factors: ~60%

• Why not Real Time Pricing from 1993?• In the traditional power system, though the increase of

load factor could significantly reduce the needed generation capacity, the reduction in retail cost is negligible.

• With expected high penetration of renewables, ToUpricing, real time pricing, and other pricing scheme may help the system again.

TRANSMISSION NETWORK

• In an electricity pool model, the operator should be able to meet the total demand. With the transmission network, it cannot.

• Local market power

Congestion fragments the system.

Markets within fragments may be highly concentrated.

These fragments emerge and disappear over time.

Empirical Evidence and Media Attention

California Energy Crisis [BBW’02]

Frequent blackouts.

800% increase in wholesale prices from April to December 2000

The total extra payments as a result of market power between 1998 and 2000 in California is estimated at approximately $5.55 billion.

Trading Profits

In New York, DC Energy LLC accounted for more than a quarter of the total $639 million in profits in the congestion markets between 2003 and 2013, The Times found.

Defining Market Power

The ability to profitably alter prices away from competitive levels. [U.S. Department of Justice]

In practice, researchers need to specify

alter prices competitive levels

The identification of market power requires ensuring that the manipulation was

profitable intentional

Detecting market power is a delicate task.

Existing works

Two main categories of market power tools and measures are in use:

Actual exercise of market power, mostly with empirical studies

e.g., analyzing historic market share [SG’84]

Identifying the potential for market power prior to the market

Pivotal Supplier Index (PSI) [BD’99] Residual Supply Index (RSI) [SC’02] Maximal Network Flow [LBH’11], TCRSI [GB’02], etc.

These indices seem to be related, but not in a clear way.

How to unify all these indices?

Revisiting RSI

𝑹𝑹𝑹𝑹𝑰𝑰𝒔𝒔 =Total Generation Capacity − Generation Capacity �𝑞𝑞𝑠𝑠

Total Demand

Residual Supply Index [SC’02]

If 𝑹𝑹𝑹𝑹𝑰𝑰𝒔𝒔 < 1, then removing generator 𝑠𝑠 will cause a shortfall of demand.

Such difference can also be interpreted as the minimal generation.

It does not include the transmission constraints and network topology.

3-bus example21

The impact of transmission constraints and network topology on the market power is significant.

~

~

6 MW

6 MW

11 MW

Bus 1 Bus 3

Bus 2

-j / 11 MVA-j

/1M

VAElectricity pool model scenario: 5 MW.

Transmission constrained scenario:

Gen 1 Gen 2Shortfall 9 MW 7 MWMinimal generation 6 MW 5 MW

3x4xx

2y

-y+y

NO STORAGE / INVENTORY

• Most commodities, inventory• Gas – pipeline• Electricity storage is expensive and it still is.

• What if storage is cheap?