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Optimal Electricity Imbalance Pricing for the Emerging Penetration of Renewable and Low-Cost Generators

Author

Listed:
  • Yashar Ghiassi-Farrokhfal

    (Rotterdam School of Management, Erasmus University, 3062 PA Rotterdam, Netherlands)

  • Rodrigo Belo

    (Nova School of Business and Economics, Universidade NOVA de Lisboa, Campus de 2775-405 Carcavelos, Portugal)

  • Mohammad Reza Hesamzadeh

    (KTH Royal Institute of Technology, 10044 Stockholm, Sweden)

  • Derek Bunn

    (London Business School, London NW1 4SA, United Kingdom)

Abstract

Problem definition : With the rise of renewables and the decline of fossil fuels, electricity markets are shifting toward a capacity mix in which low-cost generators (LCGs) are dominant. Within this transition, policymakers have been considering whether current market designs are still fundamentally fit for purpose. This research analyses a key aspect: the design of real-time imbalance pricing mechanisms. Currently, markets mostly use either single pricing or dual pricing as their imbalance pricing mechanisms. Single-pricing mechanisms apply identical prices for buying and selling, whereas dual-pricing mechanisms use different prices. The recent harmonization initiative in Europe sets single pricing as the default and dual pricing as the exception. This leaves open the question of when dual pricing is advantageous. We compare the economic efficiency of two dual-pricing mechanisms in current practice with that of a single-pricing design and identify conditions under which dual pricing can be beneficial. We also prove the existence of an optimal pricing mechanism. Methodology/results : We first analytically compare the economic efficiency of single-pricing and dual-pricing mechanisms. Furthermore, we formulate an optimal pricing mechanism that can deter the potential exercise of market power by LCGs. Our analytical results characterize the conditions under which a dual pricing is advantageous over a single pricing. We further compare the economic efficiency of these mechanisms with respect to our proposed optimal mechanism through simulations. We show that the proposed pricing mechanism would be the most efficient in comparison with others and discuss its practicability. Managerial implications : Our analytical comparison reveals market conditions under which each pricing mechanism is a better fit and whether there is a need for a redesign. In particular, our results suggest that existing pricing mechanisms are adequate at low/moderate market shares of LCGs but not for the high levels currently envisaged by policymakers in the transition to decarbonization, where the optimal pricing mechanism will become more attractive.

Suggested Citation

  • Yashar Ghiassi-Farrokhfal & Rodrigo Belo & Mohammad Reza Hesamzadeh & Derek Bunn, 2023. "Optimal Electricity Imbalance Pricing for the Emerging Penetration of Renewable and Low-Cost Generators," Manufacturing & Service Operations Management, INFORMS, vol. 25(5), pages 1966-1983, September.
    • Handle: RePEc:inm:ormsom:v:25:y:2023:i:5:p:1966-1983
    DOI: 10.1287/msom.2021.0555
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    References listed on IDEAS

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