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Locational Marginal Pricing: When and Why Not?

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  • Tesfatsion, Leigh

Abstract

Locational Marginal Pricing (LMP) implemented for grid-supported centrally-managed wholesale power markets is conceptually problematic. In analogy to the standard competitive (marginal cost = marginal benefit) spot-pricing rule, LMP assigns a common unit-price ($/MWh) to each unit (MWh) of grid-delivered energy, conditional on delivery location and time. However, competitive pricing requires the transacted asset be a commodity; that is, an asset with a standard unit of measurement such that, conditional on location and time, each trader (supplier or buyer) considers all "next" units available for trade to be perfect substitutes. In contrast, a trader’s valuation of any "next" unit (MWh) of grid-delivered energy, conditional on grid delivery location b and operating interval T, typically depends on the specific dynamic attributes of the path of power injections and/or withdrawals (MW) used to implement this delivery at b during T. One option is to muddle through, forcing suppliers, buyers, and system operators to express cost and benefit valuations for "next" units of grid-delivered energy in per-unit form ($/MWh) without regard for the true costs and benefits of flexible power delivery. Another option is to explore alternative conceptually-coherent product definitions, settlement rules, and bid/offer contract formulations enabling electric power grids to function efficiently as flexibility-support insurance mechanisms.

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  • Tesfatsion, Leigh, 2023. "Locational Marginal Pricing: When and Why Not?," ISU General Staff Papers 202307051413210000, Iowa State University, Department of Economics.
    • Handle: RePEc:isu:genstf:202307051413210000
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    References listed on IDEAS

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    1. Liu, Haifeng & Tesfatsion, Leigh S. & Chowdhury, A.A., 2009. "Derivation of Locational Marginal Prices for Restructured Wholesale Power Markets," Staff General Research Papers Archive 13068, Iowa State University, Department of Economics.
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