Pricing in Centrally Committed Electricity Markets

A long-standing issue with centrally committed electricity markets is the design of non-confiscatory and equilibrium-supporting prices. This is because the social planner’s problem in such a market is a non-convex unit commitment. O’Neill et al. (2005) propose a pricing scheme that overcomes these issues for any market that can be formulated as a mixed-integer linear program. Moreover, claims appear in the literature implying that such a payment mechanism is currently in use in a number of organized electricity markets. Using an illustrative example, we demonstrate that this is not the case. We further demonstrate that the pricing scheme proposed by O’Neill et al. (2005) has some important implications for long-run capacity investment.