The Economics of Electricity Markets

Darryl R. Biggar, Mohammad Reza Hesamzadeh

• Publisher: Wiley-IEEE Press
• Year: 2014
• Print ISBN: 9781118775752
• eBook ISBN: 9781118775721
• Edition: 1
• Topic: Physical Sciences
• Subtopic: Energy

Bridges the knowledge gap between engineering and economics in a complex and evolving deregulated electricity industry, enabling readers to understand, operate, plan and design a modern power system

With an accessible and progressive style written in straight-forward language, this book covers everything an engineer or economist needs to know to understand, operate within, plan and design an effective liberalized electricity industry, thus serving as both a useful teaching text and a valuable reference. The book focuses on principles and theory which are independent of any one market design. It outlines where the theory is not implemented in practice, perhaps due to other over-riding concerns. The book covers the basic modelling of electricity markets, including the impact of uncertainty (an integral part of generation investment decisions and transmission cost-benefit analysis). It draws out the parallels to the Nordpool market (an important point of reference for Europe). Written from the perspective of the policy-maker, the first part provides the introductory background knowledge required. This includes an understanding of basic economics concepts such as supply and demand, monopoly, market power and marginal cost. The second part of the book asks how a set of generation, load, and transmission resources should be efficiently operated, and the third part focuses on the generation investment decision. Part 4 addresses the question of the management of risk and Part 5 discusses the question of market power. Any power system must be operated at all times in a manner which can accommodate the next potential contingency. This demands responses by generators and loads on a very short timeframe. Part 6 of the book addresses the question of dispatch in the very short run, introducing the distinction between preventive and corrective actions and why preventive actions are sometimes required. The seventh part deals with pricing issues that arise under a regionally-priced market, such as the Australian NEM. This section introduces the notion of regions and interconnectors and how to formulate constraints for the correct pricing outcomes (the issue of "constraint orientation"). Part 8 addresses the fundamental and difficult issue of efficient transmission investment, and finally Part 9 covers issues that arise in the retail market.

• Bridges the gap between engineering and economics in electricity, covering both the economics and engineering knowledge needed to accurately understand, plan and develop the electricity market
• Comprehensive coverage of all the key topics in the economics of electricity markets
• Covers the latest research and policy issues as well as description of the fundamental concepts and principles that can be applied across all markets globally
• Numerous worked examples and end-of-chapter problems
• Companion website holding solutions to problems set out in the book, also the relevant simulation (GAMS) codes

Part I
Introduction to Economic Concepts

Construction of a pole-mounted transformer substation, Waitaki Electric Power Board, New Zealand, ca 1925 (Source: Neil Rennie, Power to The People: 100 Years of Public Electricity Supply in New Zealand, Electricity Supply Association of New Zealand)

1
Introduction to Micro-economics

This book is about the economics of electricity markets. It is therefore essential that the reader understands a number of basic concepts in economics. Much of the material here can be found in introductory textbooks in economics. However, we hope that setting out this material at the start of this textbook will assist readers who do not have a background in economics.

Readers who have a background in economics may choose to skip this part. However, this presentation probably contains some new material, even for readers familiar with economics. In addition, we introduce notation and a few key ideas which are used throughout the rest of the book. We recommend at least a review of this material.

1.1 Economic Objectives

Economics is the study of the production, consumption, and exchange of goods and services in an economy – including how production, consumption, and exchange are organised, how information flows and how participants are rewarded and incentivised for playing their part. Economics seeks to both create theories which explain the patterns of behaviour and organisation that we see in the real world (so-called positive theories), and to develop policies and proposals for changing the arrangements that exist in the real world (normative theories).

But, if we are to recommend changes to existing arrangements, we need a commonly agreed set of objectives that we are trying to achieve. In our view, this common set of objectives must relate, in some way, to a common vision of the overall economic welfare of the society or economy as a whole.

There may be many different ways of articulating the overall economic welfare of a society or economy, if such a thing exists at all. It may never be possible to get consensus over whether or not some alternative state of the world, B, is preferred to the status quo, A. Economists tend to focus on areas where, in principle, there could be consensus – that is, situations where, in principle, every member of society could agree that B is preferred over A. These tend to be situations where there is what might be described as waste or inefficiency – where we could reorganise things so that we could achieve the same outcomes with fewer resources, or achieve better outcomes with the same resources. If these situations exist we could, in principle, leave everyone better off.

Although there is some variation in economic theory, in practice most public policy economists make certain assumptions which simplify the task of determining the total economic welfare. Chief amongst these is the assumption that we can ignore income effects. In effect, this means that the benefit of an additional dollar to me is about the same as the benefit to any other member of the society. This assumption rules out the possibility of deriving any benefit from income redistribution alone. Alternatively, we can imagine that such income redistribution has already occurred through some other mechanism.

If we make this assumption, for any public policy change we can envisage, we can value the benefits and the costs imposed using a simple monetary metric. The change in economic welfare brought about by the public policy change is the simple sum of the monetised benefits and costs. An arrangement which maximises the economic benefits less the costs is said to be efficient. This is the usual meaning of the term economic efficiency in public policy analysis.

This notion of economic efficiency does not incorporate everything which the broader public might consider important. In particular, it does not usually directly deal with controversial questions about how income should be distributed in the economy. Neither does it normally directly address questions of fairness or equity.¹ Nevertheless, this notion of economic efficiency captures important, and broadly acceptable, notions of social welfare, and for most economists represents a legitimate g...

Table of contents

• Cover
• Title Page
• Copyright
• Preface
• Nomenclature
• Part I: Introduction to Economic Concepts
• Part II: Introduction to Electricity Networks and Electricity Markets
• Part III: Optimal Dispatch: The Efficient Use of Generation, Consumption and Network Resources
• Part IV: Efficient Investment in Generation and Consumption Assets
• Part V: Handling Contingencies: Efficient Dispatch in the Very Short Run
• Part VI: Managing Risk
• Part VII: Market Power
• Part VIII: Network Regulation and Investment
• Part IX: Contemporary Issues
• References
• Index
• End User License Agreement