11-09-2013, 12:07 PM
Transmission Pricing and Congestion Management: Efficiency, Simplicity and Open Access
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Abstract
Transmission pricing and congestion management are the key elements of a competitive electricity
market based on direct access. They have also been the focus of much of the debate concerning alternative
approaches to the market design and the implementation of a common carrier electricity system. This
paper focuses on the tradeoffs between simplicity and economic efficiency in meeting the objectives of a
transmission pricing and congestion management scheme. I contrast two extreme approaches: the postage
stamp approach vs. nodal pricing. The paper questions the wisdom of the nodal pricing paradigm on the
grounds of its rigidity and complexity. I argue that the theoretical efficiency properties of nodal pricing are
unrealistic and do not justify the implementation drawbacks of the approach. The paper explains the
underlying principles of least cost congestion relief, adopted in California that treat congestion relief as an
ancillary service and enables the ISO to relieve congestion efficiently with minimal intervention in the
energy market. I also discuss zonal aggregation and describe a new zonal priority network access pricing
that complements interzonal congestion pricing by offering a market mechanism to guide intrazonal
congestion management and provide economic signals for location of generation resources.
Introduction:
There is general agreement among academics practitioners and policy makers that direct access to the
transmission grid is the essential centerpiece for a competitive electricity market. Order 888 and Order 889
of the Federal Regulatory Energy Commission (FERC) reflect the role of direct access as the foundation for
the electric power industry restructuring. These orders provide guidelines for nondiscriminatory
transmission pricing and mandate timely disclosure of available transmission capacity but do not prescribe
a particular approach to the institution of direct access. However, the prevailing restructuring paradigm
being adopted in many states in the US has two key features: functional unbundling of generation
transmission and distribution and the transfer of control over the transmission system to an Independent
System Operator (ISO). The establishment of the ISO as a key institution in the emerging competitive
electricity markets is based on the consensus that the physical characteristics of electricity impose
requirements for real time central coordination in order to assure reliable service. However, the extent of
centralized control and “market management” that is needed to assure system reliability and that is
desirable from a social efficiency perspective has been a subject of public debate. That debate has
polarized the restructuring approaches adopted so far on the east and west coasts of the US. This
divergence manifests itself in the transmission pricing and congestion management protocols the
centerpieces of a direct access system and two of the key functions of the ISO.
Simplicity vs. Efficiency: Is Nodal Pricing Worth the Trouble?
Two opposite extremes in terms of the tradeoff between short-term efficiency and simplicity in
transmission pricing are the nodal pricing approach and the postage stamp approach. In the latter
transmission pricing takes the form of a fixed ex-ante charge per MWh for transmission service between
any two points in the grid. The simplicity and certainty of this approach is compelling from the point of
view of energy trading over the grid. However, it has been argued that the lack of locational differentiation
results in no economic signals to investors and users for efficient location of new load (e.g. production
facilities) and for the location of new generation and transmission lines. Furthermore, postage stamp
transmission pricing does not elicit economic signals from customers that could be use to manage
congestion efficiently. There is, however, little evidence as to the magnitude of the efficiency losses
resulting from the lack of correct economic signals and the debate is raging with regard to how precise
these signals need be to recapture most of these losses.
Motivated by short-run efficiency considerations, the nodal pricing approach advocated by Hogan
[1992] manages congestion and sets transmission prices through a centralized energy market based on
economic dispatch. The basic idea of the nodal pricing approach is to organize the market as a pool in
which generators (and ideally loads) submit hourly bids for node specific injection and withdrawals of
power to an Independent System Operator (ISO) with full coordination and price setting authority. The ISO
minimizes the total system's gain from trade (demand bids less supply bids) subject to transmission and
reliability constraints. The price at each node is then set to the incremental bid price of the most expansive
unit generated or consumed at the that node. These nodal prices become the hourly prices charged to loads
and paid to generators at the respective nodes. When there is no congestion all nodal prices are in theory
identical. However, even congestion on a single link could result in a different price at every node in the
system (in the WSCC there are around 2500 such nodes).
Efficient Congestion Relief without Mandatory Economic Dispatch
Zonal pricing in conjunction with incremental and decremental (inc/dec) bids for congestion relief has
been adopted in California as a less intrusive and simpler alternative to nodal pricing, which allows
efficient congestion relief with minimal interference in the energy market. The basic principle of the
California approach is to separate the energy market from congestion relief, which can be viewed as an
ancillary service. Such separation empowers the ISO to use incremental and decremental bids by bilateral
traders for the purpose of least cost congestion relief. The marginal congestion relief cost is then imposed
on the serviced interzonal transactions as a congestion charge. The ISO, however, is not allowed to
interfere in the energy market by using the inc/dec bids for the purpose of displacing "inefficient"
generation beyond congestion relief needs.
The technical details of the California implementation are described by Papalexopoulos, Singh and
Angelidis [1998]. I will illustrate here the basic principles of least cost congestion relief with a simple two-
zone example. Figure 1 illustrates three interzonal bilateral transactions scheduled by three scheduling
coordinators (SC). Each SC has its own supply and demand curve representing its load and generation
capacity, which leads to its preferred schedule. In our example the preferred transaction quantity of each
SC is chosen to maximize gains from trade (represented by shaded area). The corresponding cost of the
marginal transaction unit varies across SCs (it is 17 for SC1, 15 for SC2 and 12 for SC3). It should also be
noted that the energy settlement price of each SC depends on contractual arrangement and may differ from
marginal cost. Each SC submits to the ISO a preferred schedule, which in this example is 1000MW. Since
the interzonal transmission capacity is limited to 1500MW ISO intervention is needed to relieve
congestion. In addition to a preferred schedule each SC submits inc/dec bids for congestion relief on both
sides of the transmission line.
Conclusion
Short term theoretical efficiency claims of the nodal pricing approach to transmission tariffs and
congestion management are based on unrealistic assumptions and a myopic view of optimal resource use.
Hence, such claims do not justify the burden of thousands of different prices, the drawbacks of ex-post
transmission charges and the constraints imposed on bilateral transactions and on risk management. Zonal
aggregation and decoupling of the energy market from congestion relief protocols simplify transmissionpricing and congestion management without substantial short-term efficiency losses. Such simplifications
offer more certainty of transmission cost to traders and better risk management capability. They also enable
a higher degree of decentralization in the energy market, which will promote innovation and long-term
efficiency.