Fundamentals of Power System Economics

Preface to the First Edition xiii Preface to the Second Edition xv 1 Introduction 1 1.1 Why Competition? 1 1.2 Market Structures and Participants 2 1.2.1 Traditional Model 2 1.2.2 Introducing Independent Power Producers 4 1.2.3 Wholesale Competition 5 1.2.4 Retail Competition 6 1.2.5 Renewable and Distributed Energy Resources 6 1.3 Dramatis Personae 7 1.4 Competition and Privatization 8 1.5 Experience and Open Questions 9 1.6 Problems 10 Further Reading 11 2 Basic Concepts from Economics 13 2.1 Introduction 13 2.2 Fundamentals of Markets 13 2.2.1 Modeling the Consumers 13 2.2.1.1 Individual Demand 13 2.2.1.2 Surplus 14 2.2.1.3 Demand and Inverse Demand Functions 15 2.2.1.4 Elasticity of Demand 18 2.2.2 Modeling the Producers 18 2.2.2.1 Opportunity Cost 18 2.2.2.2 Supply and Inverse Supply Functions 19 2.2.2.3 Producers’ Revenue 20 2.2.2.4 Elasticity of Supply 20 2.2.3 Market Equilibrium 22 2.2.4 Pareto Efficiency 24 2.2.5 Global Welfare and Deadweight Loss 25 2.2.6 Time-varying Prices 26 2.3 Concepts from the Theory of the Firm 27 2.3.1 Inputs and Outputs 27 2.3.2 Long Run and Short Run 27 2.3.3 Costs 30 2.3.3.1 Short-run Costs 30 2.3.3.2 Long-run Costs 32 2.4 Risk 34 2.5 Types of Markets 34 2.5.1 Spot Market 35 2.5.2 Forward Contracts and Forward Markets 35 2.5.3 Futures Contracts and Futures Markets 37 2.5.4 Options 38 2.5.5 Contracts for Difference 39 2.5.6 Managing the Price Risks 40 2.5.7 Market Efficiency 41 2.6 Markets with Imperfect Competition 41 2.6.1 Market Power 41 2.6.2 Monopoly 42 2.7 Problems 43 Further Reading 49 3 Markets for Electrical Energy 51 3.1 What Is the Difference Between a Megawatt-hour and a Barrel of Oil? 51 3.2 Trading Periods 52 3.3 Forward Markets 53 3.3.1 Bilateral or Decentralized Trading 54 3.3.2 Centralized Trading 57 3.3.2.1 Principles of Centralized Trading 57 3.3.2.2 Day-ahead Centralized Trading 59 3.3.2.3 Formulation as an Optimization Problem 60 3.3.2.4 Market Clearing Price 61 3.3.2.5 Recovering the Fixed Costs 63 3.3.3 Comparison of Centralized and Decentralized Trading 67 3.4 Spot Markets 68 3.4.1 Obtaining Balancing Resources 69 3.4.2 Gate Closure 70 3.4.3 Operation of the Spot Market 70 3.4.4 Interactions Between the Spot Market and the Forward Market 72 3.5 The Settlement Process 73 3.6 Problems 75 References 86 Further Reading 86 4 Participating in Markets for Electrical Energy 89 4.1 Introduction 89 4.2 The Consumer’s Perspective 89 4.3 The Retailer’s Perspective 91 4.4 The Producer’s Perspective 98 4.4.1 Perfect Competition 98 4.4.1.1 Basic Dispatch 98 4.4.1.2 Unit Limits 99 4.4.1.3 Piecewise Linear Cost Curves 100 4.4.1.4 No-load Cost 101 4.4.1.5 Scheduling 102 4.4.1.6 Startup Cost 103 4.4.1.7 Operating Constraints 104 4.4.1.8 Environmental Constraints 105 4.4.1.9 Other Economic Opportunities 105 4.4.1.10 Forecasting Errors 105 4.4.2 The Produce Vs Purchase Decision 105 4.4.3 Imperfect Competition 107 4.4.3.1 Bertrand Model 108 4.4.3.2 Cournot Model 109 4.4.3.3 Supply Functions Equilibria 116 4.4.3.4 Agent-Based Modeling 117 4.4.3.5 Experimental Economics 117 4.4.3.6 Limitations of These Models 117 4.5 Perspective of Plants That Do Not Burn Fossil Fuels 117 4.5.1 Nuclear Power Plants 118 4.5.2 Hydroelectric Power Plants 118 4.5.3 Wind and Solar Generation 119 4.5.3.1 Intermittency and Stochasticity 119 4.5.3.2 Government Policies and Subsidies 119 4.5.3.3 Effect on the Markets 120 4.6 The Storage Owner’s Perspective 121 4.6.1 Self-scheduling 121 4.6.2 Centralized Operation 122 4.7 The Flexible Consumer’s Perspective 125 4.7.1 Flexible Demand Vs Storage 125 4.7.2 Remunerating Flexible Demand 126 4.7.3 Implementation Issues 126 4.8 The Neighbor’s Perspective 131 4.9 An Overall Market Perspective 131 4.9.1 Clearing the Market 131 4.9.2 Exercising Market Power 133 4.9.3 Dealing with Market Power 135 4.10 Problems 136 Further Reading 138 5 Transmission Networks and Electricity Markets 141 5.1 Introduction 141 5.2 Decentralized Trading over a Transmission Network 141 5.2.1 Physical Transmission Rights 142 5.2.2 Problems with Physical Transmission Rights 143 5.2.2.1 Parallel Paths 143 5.2.2.2 Example 144 5.2.2.3 Physical Transmission Rights and Market Power 147 5.3 Centralized Trading over a Transmission Network 148 5.3.1 Centralized Trading in a Two-Bus System 148 5.3.1.1 Unconstrained Transmission 149 5.3.1.2 Constrained Transmission 150 5.3.1.3 Congestion Surplus 153 5.3.2 Centralized Trading in a Three-Bus System 155 5.3.2.1 Economic Dispatch 156 5.3.2.2 Correcting the Economic Dispatch 159 5.3.2.3 Nodal Prices 162 5.3.2.4 Congestion Surplus 167 5.3.2.5 Economically Counterintuitive Flows 167 5.3.2.6 Economically Counterintuitive Prices 169 5.3.2.7 More Economically Counterintuitive Prices 171 5.3.2.8 Nodal Pricing and Market Power 171 5.3.2.9 A Few Comments on Nodal Marginal Prices 173 5.3.3 Losses in Transmission Networks 174 5.3.3.1 Types of Losses 174 5.3.3.2 Marginal Cost of Losses 174 5.3.3.3 Effect of Losses on Generation Dispatch 176 5.3.3.4 Merchandising Surplus 178 5.3.3.5 Combining Losses and Congestion 178 5.3.3.6 Handling of Losses Under Bilateral Trading 179 5.3.4 Mathematical Formulation of Nodal Pricing 179 5.3.4.1 Network with a Single Busbar 179 5.3.4.2 Network of Infinite Capacity with Losses 180 5.3.4.3 Network of Finite Capacity with Losses 182 5.3.4.4 Network of Finite Capacity, DC Power Flow Approximation 184 5.3.4.5 AC Modeling 187 5.3.5 Managing Transmission Risks in a Centralized Trading System 188 5.3.5.1 The Need for Network-Related Contracts 188 5.3.5.2 Financial Transmission Rights 189 5.3.5.3 Point-to-Point Financial Transmission Rights 191 5.3.5.4 Flowgate Rights 195 5.4 Problems 195 References 202 Further Reading 202 6 Power System Operation 203 6.1 Introduction 203 6.1.1 The Need for Operational Reliability 203 6.1.2 The Value of Reliability 204 6.1.3 The Cost of Reliability 204 6.1.4 Procuring Reliability Resources 206 6.1.5 Outline of the Chapter 206 6.2 Operational Issues 207 6.2.1 Balancing Issues 207 6.2.1.1 Balancing Resources 210 6.2.1.2 Effect of Generation from Stochastic Renewable Sources 212 6.2.2 Network Issues 212 6.2.2.1 Limits on Power Transfers 212 6.2.2.2 Voltage Control and Reactive Support 214 6.2.2.3 Stability Services 218 6.2.3 System Restoration 218 6.2.4 Market Models Vs Operational Models 219 6.3 Obtaining Reliability Resources 219 6.3.1 Compulsory Provision 219 6.3.2 Market for Reliability Resources 220 6.3.3 System Balancing with a Significant Proportion of Variable Renewable Generation 221 6.3.4 Creating a Level-playing Field 222 6.4 Buying Reliability Resources 223 6.4.1 Quantifying the Needs 223 6.4.2 Co-optimization of Energy and Reserve in a Centralized Electricity Market 224 6.4.3 Allocation of Transmission Capacity Between Energy and Reserve 232 6.4.4 Allocating the Costs 237 6.4.4.1 Who Should Pay for Reserve? 237 6.4.4.2 Who Should Pay for Regulation and Load Following? 238 6.5 Selling Reliability Resources 238 6.6 Problems 243 References 246 Further Reading 247 7 Investing in Generation 249 7.1 Introduction 249 7.2 Generation Capacity from an Investor’s Perspective 249 7.2.1 Building New Generation Capacity 249 7.2.2 Retiring Generation Capacity 255 7.2.3 Effect of a Cyclical Demand 257 7.3 Generation Capacity from the Customers’ Perspective 260 7.3.1 Expansion Driven by the Market for Electrical Energy 261 7.3.2 Capacity Payments 263 7.3.3 Capacity Market 264 7.3.4 Reliability Contracts 265 7.4 Generation Capacity from Renewable Sources 266 7.4.1 The Investors’ Perspective 266 7.4.2 The Consumers’ Perspective 267 7.5 Problems 267 References 269 Further Reading 270 8 Investing in Transmission 271 8.1 Introduction 271 8.2 The Nature of the Transmission Business 272 8.3 Cost-Based Transmission Expansion 273 8.3.1 Setting the Level of Investment in Transmission Capacity 274 8.3.2 Allocating the Cost of Transmission 274 8.3.2.1 Postage Stamp Method 275 8.3.2.2 Contract Path Method 275 8.3.2.3 MW-mile Method 276 8.3.2.4 Discussion 276 8.4 The Arbitrage Value of Transmission 276 8.4.1 The Transmission Demand Function 278 8.4.2 The Transmission Supply Function 280 8.4.3 Optimal Transmission Capacity 281 8.4.4 Balancing the Cost of Constraints and the Cost of Investments 282 8.4.5 Effect of Load Fluctuations 283 8.4.5.1 Load-duration Curve 284 8.4.5.2 Recovery of Variable Transmission Investment Costs 287 8.4.6 Revenue Recovery for Suboptimal Transmission Capacity 288 8.4.7 Economies of Scale 290 8.4.8 Transmission Expansion in a Meshed Network 292 8.4.9 Concept of Reference Network 298 8.4.9.1 Notations 298 8.4.9.2 Problem Formulation 300 8.4.9.3 Implementation 300 8.4.9.4 Considering Other Factors 303 8.5 Other Sources of Value 303 8.5.1 Sharing Reserve 303 8.5.2 Sharing Balancing Capacity 306 8.5.3 Sharing Generation Capacity Margin 308 8.6 Decentralized Transmission Expansion 310 8.6.1 Concept 310 8.6.2 Illustration on a Two-bus System 311 8.7 Non-wires Alternatives for Transmission Expansion 314 8.8 Problems 315 References 316 Further Reading 317 Index 319