Electricity Markets

Theories and Applications

Jeremy Lin, Fernando H. Magnago

• Editorial: Wiley-IEEE Press
• Año: 2017
• ISBN:
  9781119179375
• Edición: 1
• Categoría: Scienze fisiche
• Categoría: Energia

A comprehensive resource that provides the basic concepts of electric power systems, microeconomics, and optimization techniques

Electricity Markets: Theories and Applications offers students and practitioners a clear understanding of the fundamental concepts of the economic theories, particularly microeconomic theories, as well as information on some advanced optimization methods of electricity markets. The authors—noted experts in the field—cover the basic drivers for the transformation of the electricity industry in both the United States and around the world and discuss the fundamentals of power system operation, electricity market design and structures, and electricity market operations.

The text also explores advanced topics of power system operations and electricity market design and structure including zonal versus nodal pricing, market performance and market power issues, transmission pricing, and the emerging problems electricity markets face in smart grid and micro-grid environments. The authors also examine system planning under the context of electricity market regime. They explain the new ways to solve problems with the tremendous amount of economic data related to power systems that is now available. This important resource:

• Introduces fundamental economic concepts necessary to understand the operations and functions of electricity markets
• Presents basic characteristics of power systems and physical laws governing operation
• Includes mathematical optimization methods related to electricity markets and their applications to practical market clearing issues

Electricity Markets: Theories and Applications is an authoritative text that explores the basic concepts of the economic theories and key information on advanced optimization methods of electricity markets.

Chapter 1
Introduction

This beginning chapter will provide a high-level overview of the topics related to the basic drivers and transformation of electricity industry around the world. With that tremendous change come challenges and complex issues. One of the key developments in this transformation is the development of electricity markets. This is the main topic of this book. In fact, the primary and paramount goal of an electric power system operation is to maintain a high level of reliability. Under a restructured environment, this goal of system reliability is achieved via a market mechanism. Understanding electricity markets requires both basic understanding and advanced knowledge of electrical power engineering principles, microeconomic theories, and optimization methods from the field of operations research. Therefore, the fundamentals of these topics will be covered in the first few chapters.

1.1 ELECTRIC POWER SYSTEM

Electricity is indispensable for a modern society. The marvels of a modern life that we enjoy today cannot be possible without electricity. The importance of electricity is without questions. So, how do we get electricity?

In general, electricity is generated from electric generating sources located far from the load centers, then transmitted over long distances using transmission lines, and distributed to the load customers which include factories, offices, and homes. The entire chain of this system is known as electric power system.

The electric power system as we know of today was developed more than a 100 years ago. It generally consists of generation, transmission, and distribution subsystems. The entire chain of business from generation to transmission and distribution to load customers for a particular service area is owned by a single entity, known as an electric power company or electric utility company. The electric power company is either owned and operated by a national government or can be a public company owned by investors, but operated by management and employees of the company. Therefore, electric power industry is an important part of a country’s infrastructure.

For the last two decades, the electricity industry around the world has undergone a tremendous transformation. This transformation is from a traditional structure of an electric power industry typically owned by national governments or public investors (as in investor-owned utilities) towards a structure that is exposed to a competitive market environment. This transformation in electricity industry was preceded by similar transformations in other industries such as airlines, trucking, and natural gas industries. In the case of an electric utility owned by a national government, this transformation is in the form of privatization first, then the privatized company is exposed to an open, competitive market environment. This was the case for electricity industry restructuring in Argentina. In the case of an investor-owned utility as in the United States, the generation part of the business was separated from the wires part (transmission and distribution systems) of the same company. This generation business is either divested to an independent company or completely formed as a separate subsidiary of the original utility. This is equivalent to the functional unbundling of an existing vertically integrated company.

The key outcome of this entire industry transformation, which is generally known as electricity industry restructuring, is the development and establishment of electricity markets. This is achieved by breaking up generation services into a separate, more competitive segment of the industry while the transmission and distribution parts of the utility service largely remain a regulated monopoly service. Because of unbundling of services (generation vs. transmission and distribution), these services have to be priced separately on a customer’s bill.

Generally, in an electricity market, generators (generator owners) compete among each other to have an opportunity to supply electricity to serve load customers at the other end of the wires. However, the transmission and distribution parts of the system (electric power system) are not open for competition because it is generally believed that the wires business is subject to a natural monopoly behavior. A firm with natural monopoly enjoys significant economies of scale. It has to be properly regulated due to potential market power issues.

Therefore, the competition among generators is one of the key developments when the electric power industry was restructured. As a consequence, the analysis of the strategic interactions among the competing generators becomes an important subject to explore. These topics will be covered in more detail in later chapters. Natural monopoly part of the system, that is, transmission and distribution system, is still regulated because it will create more inefficiencies in the system if more than one firm are allowed to compete for wires business. One way to effectively regulate the network system is to form an independent entity that would control and operate the network only with or without the ownership of these facilities. While such entities may carry different names, such as independent system operator (ISO), transmission system operator (TSO), or regional transmission organization (RTO), the key functions of these entities are essentially the same. The mandate of these entities is to operate and manage the network system in a fair, least-cost, and most-efficient manner so that generators can compete effectively on a level playing field. The primary goal of operating the network in such a manner is to increase the economic efficiency of the system, and thus increase the social welfare. However, there might be some variations among these system operators in the areas of ownership, non-profit or for-profit, financial and capital structures, and governance. The list here is not exhaustive, but just descriptive. These topics are beyond the scope of this book.

In the electricity market setting, electricity is treated as another commodity. However, electricity must be generated simultaneously with demand which constantly fluctuates. As a result, an additional capacity, called the reserve margin, must be available to compensate for planned and unplanned outages of generating plants as well as spikes in demand. In a sense, the unique characteristics of electricity provide challenges unlike any of the other industries that has been deregulated. Sometimes, some sort of intervention is needed to ensure adequate supply. There are some imperfections in the competitive wholesale market operations, so some kind of reforms or interventions are generally needed.

1.2 ELECTRICITY INDUSTRY RESTRUCTURING IN THE UNITED STATES

The electric power system in North America is divided into three large regions: Eastern Interconnection, Western Interconnection, and ERCOT Interconnection, where ERCOT stands for Electric Reliability Council of Texas, as shown in Figure 1.1. Each interconnection operates its own system with small ties to other interconnections. The nominal system frequency for the entire system, including all three interconnections, is 60 Hz.

Figure 1.1 Electric Power System in North America.

1.2.1 Key Drivers for Electricity Industry Restructuring

It is generally believed that the following are the key reasons and drivers behind the electricity industry restructuring:

1. Technological changes
2. High electricity costs
3. Overall system inefficiencies
4. Higher environmental restrictions

Technological changes have been an important driver to allow the implementation of competitive schemes in an industry which had been historically considered as a natural monopoly. New technologies make it economical for competitors to provide electric generation services to electricity consumers, particularly industrial customers, which were traditionally served by incumbent utilities. Legal authority given to large industrial users to bypass the local utility provided more impetus to the industry restructuring.

In large part, the action was prompted by the burden of having a higher or the highest electricity costs in the country, which created hardships for residential consumers and handicapped many businesses from competing on a “level playing field” with companies located outside the region. For example, New England was one of the first regions of the country to restructure the industry. The persistently high cost of electricity which put the region at a competitive disadvantage was another driving force behind the push for further competition in the generation sector.

Another key driver in restructuring efforts was the environmental protection whose goal is to reduce atmospheric emissions from generating electricity. More rigorous air emission standards and regulations led to the construction of new natural gas-fired generating plants which, in turn, led to emission reduction and air-quality improvements. The new cleaner generators have displaced the older, inefficient, and polluting generating plants. Environmental protection rules, such as the Clean Air Act and subsequent federal rules along with the state’s air quality regulations led to increased environmental benefits. The key pollutants that caused global environmental issues are sulfur dioxide (SO₂) which is responsible for acid rain, nitrogen oxide (NO

) which produces smog, and carbon dioxide (CO₂) which is one of the key drivers of global warming.

The main objective of industry restructuring was to create a fair and reliable market for competition in generating electricity while ensuring equal access to transmission grids. The other objectives were to achieve lower electricity rates and enhance economic growth. Once established, the wholesale market treats electricity as a commodity with prices set not by regulators, but by market rules and the balance between supply and demand.

1.2.2 Pre-Federal Energy Regulatory Commission Order 2000

Traditionally, the majority of the electric utilities in the United States is formed as investor-owned utilities (IOUs). Some utilities are owned by the federal government and some are owned by municipalities and cooperatives. The vertically integrated utilities are granted franchise areas with the exclusive right to provide electric service. In exchange for this monopoly right, almost every aspect of their business was regulated by state's public utility commissions (PUCs) within their state boundaries. State PUCs set the operating standards for electric service, authorize the utilities to invest in new facilities such as power plants, transmission lines, or other equipments needed to meet their customer service obligations, and set the rates that customers pay for electricity service. Electric utilities are responsible for supplying electricity to load customers in their service territories.

The US Congress laid the groundwork for deregulating or restructuring wholesale electricity markets through provisions contained in the Public Utility Regulatory Policies Act of 1978 (PURPA). The Act mandated that regulated electric utilities provide a market for the output of non-utility generating (or power) plants that meet certain size, technology, and environmental criteria. Many state regulators required utilities to sign long-term power purchase contracts with small, independent PURPA generators at the utilities’ then-avoided costs. Power plants that were built pursuant to PURPA represented the beginning of a new class of generators called independent power producers (IPP). Furthermore, pursuant to the state-mandated integrated resource planning processes, regulators required utilities to compare the cost of utility-built generation with that from IPP’s generation and to take the least-cost alternative. This regulatory paradigm resulted in the maturation of the IPP industry across the country.

Thereafter, Congress passed the Energy Policy Act of 1992 which advanced the move to competition in wholesale markets. The Act gave Federal Energy Regulatory Commission (FERC) an authority to order utilities to provide transmission access to third parties in the wholesale electricity markets. This began the process of allowing open access to the existing transmission system to non-utility generators. This also created a condition in which there were increased competitions among generators owned by electric utilities and IPPs.

Subsequently, FERC issued Orders 888 and 889 in April 1996, which authorized open and equal access to all utilities’ transmission lines for ...