A Spatial “ Smart Market ” for Electric Power and Transmission

Creating successful competitive electric power markets requires transmission pricing reform. Due to the physics of power transmission networks, efficient transmission prices must incorporate two types of loop flow externalities, and must be determined jointly with efficient power (nodal) prices. Prior proposed market schemes all involve an approximation to the efficient prices. I propose a real-time “smart market” that provides incentives for truthful revelation of the information required for finding the correct efficient prices. Address. Prof. Jeffrey K. MacKie-Mason, Dept. of Economics, University of Michigan, Ann Arbor, MI 48109-1220. E-mail: [email protected]. A Spatial “Smart Market” for Electric Power and Transmission Jeffrey K. MacKie-Mason 1. Efficient Short-Run Pricing The entire institutional and market structure of the electric power industry is in turmoil in many countries. The U.K. has deregulated the power market, and created a central transmission pool (Newberry and Green (1995)). New Zealand has been implementing short-run marginal cost pricing for power (Ring (1994)). Regulators at both state and federal levels in the U.S. have been studying radical transformations. For example, the California PUC recently proposed retail competition among power providers (Blumstein and Bushnell (1994)). Transmission pricing reform is essential to the creation of competitive power markets. A power system consists of supply (generator) and demand (load) nodes, connected by a transmission grid. By delivering power over the grid, multiple suppliers can compete to serve a given demand. However, building a transmission grid involves huge fixed costs relative to variable operating costs, and thus for the forseeable future crucial components of a grid will be natural monopolies. The regulation and pricing of transmission access will determine the success of power market competition. Transmission grids are extraordinarily complex engineering systems. The delivery of power from one node to another may involve flows along several “parallel” paths; the actual flows are determined by physics, not economics or contractual arrangements. As a result, the flows induced by one power transaction may affect the costs incurred by others on the grid who are not participants in the transaction. Two types of external effects are common: flows induced by a transaction may (1) raise marginal transmission losses for other grid users; and (2) raise marginal generation costs if transmission line constraints become binding. Power grid physics require that efficient prices for both power and transmission be found jointly as the solution to an optimization problem. The extent to which a regulatory reform obtains I have benefitted from conversations with Ed Kahn, Bart McGuire and Matthew White. I undertook the research for this paper while visiting the California Energy Institute, University of California, Berkeley; I am grateful for the financial support provided by UCEI.