POWER SYSTEM

ECONOMICS
T, 6:30 PM – 8:30 PM
 ✓ Electricity vs. Other Commodities
✓ Trading Periods
✓ Forward Markets
• Bilateral or Decentralized Trading
• Centralized Trading
• Principles of Centralized Trading
• Day-ahead Centralized Trading
MARKETS FOR • Formulation as an Optimization Problem
• Market Clearing Price
ELECTRICAL ENERGY • Comparison of Centralized and Decentralized
Trading
✓ Spot Markets
• Operation of the Spot Market
✓ The Settlement Process
MARKETS FOR ELECTRICAL ENERGY

Assume that all generators and loads are connected to

the same bus.

Ignore for now the complexities introduced by the

transmission and distribution networks and concentrate
on the trading of electrical energy.

Electrical energy must be produced at pretty much the

same time as it is consumed.

Trade in electrical energy, therefore, always refers to a

certain amount of megawatt-hours to be delivered over
a specified period of time.

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❑ Difference between Electrical Energy and
Other Commodities
The supply of electrical energy is linked with a physical system and that its delivery occurs on a
continuous rather than a batch basis.

▪ In this physical power system, generators, consumers, and the wires that connect them
are mutually dependent and cannot be treated like fully independent entities.

▪ In particular, supply and demand – generation and load – must be balanced on a second-
by-second basis.

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❑ Difference between Electrical Energy and
Other Commodities
The energy produced by one generator cannot be directed to a specific consumer. Conversely, a
consumer cannot take energy from only one generator.

▪ Instead, the power produced by all generators is pooled on its way to the loads.

▪ This pooling is possible because units of electrical energy produced by different

generating units are indistinguishable.

▪ It is also desirable because pooling produces valuable economies of scale: the maximum
generation capacity must be commensurate with the maximum aggregated demand
rather than with the sum of the maximum individual demands.

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❑ Difference between Electrical Energy and
Other Commodities
The demand for electrical energy exhibits predictable daily and weekly cyclical variations.

▪ Electricity is by no means the only commodity for which the demand is cyclical.

▪ Its short-run price elasticity of demand is very small, matching supply and demand
requires production facilities capable of following the large and rapid changes in
consumption that take place over the course of a day.

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❑ Difference between Electrical Energy and
Other Commodities

The only energy that is actually stored and readily available in

the power system resides in the rotating masses of
synchronized generators. Since this stored kinetic energy is
quite small, a sudden deficit in generation would deplete it
quite quickly, causing a drop in frequency that could not be
corrected sufficiently fast by a market mechanism.

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❑ Trading Periods

The quantity that best defines a tradable commodity is clearly the energy supplied.

For Consumers:
amount of energy consumed → variable that is most closely related to the value that
they obtain from consuming electricity.
For Generators:
cost of production → to the amount of energy generated.

Electricity is traded in terms of power over a certain interval of time

(kilowatt-hours).

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❑ Trading Periods

✓ Designing an electricity market involves choosing a time interval that serves as a trading period.
Power is then translated into tradable energy by integrating it over each time interval.

✓ Electricity trading is organized as a sequence of forward markets with progressively shorter trading
periods and a spot market.

✓ Forward markets handle trading in large amounts of energy over long periods of time. They operate
slowly and close far in advance of the beginning of the delivery period (also known as “real time”).

This arrangement not only helps market participants manage their risks but also gives the system
operator time to identify conditions that might affect the operational reliability of the system.

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❑ Forward Markets

Forward markets normally involve a substantial number of bids to buy and offers to sell. Over time,
repeated interactions between the participants, leading to bilateral trades, clear the market.

Decentralized Centralized

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❑ Forward Markets
Bilateral or Decentralized Trading

• Customized long-term contracts: The terms of such contracts are negotiated privately to meet the needs and objectives of both
parties and are thus very flexible. They usually involve the sale of large amounts of power (hundreds or thousands of MW) over
long periods of time (several months to several years). Negotiating such contracts carries substantial transaction costs and thus
make them worthwhile only when the parties want to trade large amounts of energy.

• Trading “over the counter”: These transactions involve smaller amounts of energy to be delivered according to a standard
profile, i.e. a standardized definition of how much energy should be delivered over different periods of the day and week.

• Electronic trading: Participants use electronic trading platforms to advertise offers to sell or bids to buy energy. All participants in
such a computerized marketplace can observe the quantities and prices submitted by other parties but do not know the identity
of the party that submitted each bid or offer.

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❑ Forward Markets
Bilateral or Decentralized Trading

❑ The essential characteristic of bilateral trading is that the price of each transaction is set independently by
the parties involved.

❑ There is thus no “official” price and trading can be described as “decentralized.”

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❑ Forward Markets
Centralized Trading

❑ Rather than relying on repeated interactions between suppliers and consumers to reach a market
equilibrium, a centralized electricity market provides a mechanism for determining this equilibrium in a
systematic way.

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❑ Forward Markets
Centralized Trading

A centralized market operates as follows:

❑ Generating companies submit offers to supply a certain amount of electrical power at a certain price for the
period under consideration. These offers are ranked in order of increasing price. From this ranking, a curve
showing the offer price as a function of the cumulative quantity offered can be built. This curve is deemed
to be the supply curve of the market.

❑ The demand curve is assumed to be a vertical line at the value of the load forecast.

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❑ Forward Markets
Centralized Trading

❑ System Marginal Price (SMP) - market clearing price represents the price of one additional megawatt-hour
of energy.

❑ Generators are paid this SMP for every megawatt-hour that they produce and consumers pay the SMP for
every megawatt-hour that they consume, irrespective of the offers and bids that they submitted.

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❑ Forward Markets
Centralized Trading

Day-ahead Centralized Trading

Treating each hourly trading period separately is not practical for a number of technical and economic reasons:

▪ Synchronizing a large thermal generating unit to the system can take several hours.
▪ Once synchronized, such a unit must often continue producing power for a certain number of hours to
avoid mechanical damage caused by excessive temperature gradients.
▪ Similarly, once it has been shut down, it must typically remain idle for a certain number of hours before
it can be restarted. The output of large generating units usually cannot be reduced to zero. Instead, it
must remain above its “minimum stable generation,” which can be a significant fraction of its rated
output.
▪ The rate at which the output of a unit can increase or decrease is also limited.

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❑ Forward Markets
Centralized Trading

Formulation as an Optimization Problem

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❑ Forward Markets
Centralized Trading

Formulation as an Optimization Problem

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❑ Forward Markets
Centralized Trading

Market Clearing Price

▪ Given the schedule produced by this optimization, one can calculate the market clearing price for each
trading period.

▪ Since in a competitive market this price should reflect the cost of producing one additional megawatt-
hour, this price should be set at the marginal cost of the most expensive generating unit scheduled to
produce power for each trading period.

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❑ Spot Markets
Schematic diagram of the operation of a managed spot market for electricity.

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❑ The Settlement Process
1. The net position of every market participant is determined.
2. Each generator must report to the settlement system the net amount of energy that it had
contracted to sell for each period.
3. This amount is subtracted from the amount of energy that it actually produced. If the result is
positive, the generator is deemed to have sold this excess energy to the system. On the other
hand, if the result is negative, the generator is treated as if it had bought the difference from the
system.

Settlement in a centralized electricity market is more straightforward because all physical transactions are
handled by the system operator. These markets typically implement what is called a “two-settlement system.” In
such a system, quantities scheduled on the day-ahead market are settled at the day-ahead price, while deviations
between scheduled and actual quantities for each market period are settled at the spot market (real-time) price
for that market period.

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