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Fundamentals of Power System Economics

This document provides a summary of the key concepts in power system economics. It begins with an introduction to competition models in the electricity industry and discusses open questions. It then covers basic economics concepts relevant to power systems like modeling of consumers and producers, market equilibrium, and imperfect competition. Subsequent chapters discuss markets for electrical energy, participating in these markets from different perspectives, ancillary services, transmission networks, investing in generation and transmission capacity. The document aims to explain fundamental economic principles underlying power system operation and planning.

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Gurdeep singh Bali
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485 views5 pages

Fundamentals of Power System Economics

This document provides a summary of the key concepts in power system economics. It begins with an introduction to competition models in the electricity industry and discusses open questions. It then covers basic economics concepts relevant to power systems like modeling of consumers and producers, market equilibrium, and imperfect competition. Subsequent chapters discuss markets for electrical energy, participating in these markets from different perspectives, ancillary services, transmission networks, investing in generation and transmission capacity. The document aims to explain fundamental economic principles underlying power system operation and planning.

Uploaded by

Gurdeep singh Bali
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
  • Introduction

Fundamentals of Power

System Economics

Daniel Kirschen
Goran Strbac
University ofManchester Institute of Science & Technology (UMIST), UK

John Wiley & Sons, Ltd


Contents

PREFACE xi

1 INTRODUCTION 1
1.1 Why Competition? 1
1.2 Dramatis Personae 2
1.3 Models of Competition 4
1 .3 .1 Model 1 : Monopoly 4
1 .3 .2 Model 2: Purchasing agency 4
1 .3 .3 Model 3: Wholesale competition 5
1 .3 .4 Model 4: Retail competition 6
1 .3 .5 Competition and privatization 7
1 .4 Open Questions 7
1 .5 Further Reading 8
1 .6 Problems 9

2 BASIC CONCEPTS FROM ECONOMICS 11


2.1 Introduction 11
2.2 Fundamentals of Markets 11
2.2.1 Modeling the consumers 11
2.2 .2 Modeling the producers 17
2.2 .3 Market equilibrium 21
2.2 .4 Pareto efficiency 22
2.2 .5 Global welfare and deadweight loss 24
2 .3 Concepts from the Theory of the Firm 25
2.3 .1 Inputs and outputs 25
2.3 .2 Long run and short run 26
2.3 .3 Costs 29
2.4 Types of Markets 33
2 .4 .1 Spot market 33
2.4 .2 Forward contracts and forward markets 34
vw CONTENTS

2.4 .3 Future contracts and futures markets 36


2.4 .4 Options 37
2.4 .5 Contracts for difference 38
2.4.6 Managing the price risks 39
2.4.7 Market efficiency 39
2.5 Markets with Imperfect Competition 39
2.5 .1 Market power 39
2 .5 .2 Models of imperfect markets 40
2.5 .3 Monopoly 43
2.6 Further Reading 44
2 .7 Problems 45

3 MARKETS FOR ELECTRICAL ENERGY 49


3.1 Introduction 49
3.2 What is the Difference Between a Megawatt-Hour and a Barrel of Oil? 49
3.3 The Need for a Managed Spot Market 51
3.4 Open Electrical Energy Markets 52
3.4 .1 Bilateral trading 52
3.4 .2 Electricity pools 55
3.4 .3 Comparison of pool and bilateral trading 58
3.5 The Managed Spot Market 59
3.5 .1 Obtaining balancing resources 60
3.5 .2 Gate closure 61
3.5 .3 Operation of the managed spot market 61
3 .5 .4 Interactions between the managed spot market and the other
markets 63
3.6 The Settlement Process 64
3.7 Further Reading 66
3.8 Problems 67

4 PARTICIPATING IN MARKETS FOR ELECTRICAL ENERGY 73


4.1 Introduction 73
4.2 The Consumer's Perspective 73
4.2 .1 Retailers of electrical energy 75
4.3 The Producer's Perspective 79
4.3 .1 Perfect competition 80
4.3 .2 The production versus purchase decision 88
4.3 .3 Imperfect competition 90
4.4 Perspective of Plants with Very Low Marginal Costs 99
4.5 The Hybrid Participant's Perspective 99
4.6 Further Reading 101
4.7 Problems 102
5 SYSTEM SECURITY AND ANCILLARY SERVICES 105
5.1 Introduction 105
5.2 Describing the Needs 107
5.2 .1 Balancing issues 107
5.2 .2 Network issues 111
5.2 .3 System restoration 117
5.3 Obtaining Ancillary Services 117
5.3 .1 Compulsory provision of ancillary services 118
5.3 .2 Market for ancillary services 119
5 .3 .3 Demand-side provision of ancillary services 119
5.4 Buying Ancillary Services 120
5.4.1 Quantifying the needs 120
5.4 .2 Co-optimization of energy and reserve in a centralized
electricity market 121
5.4 .3 Allocating the costs 129
5.5 Selling Ancillary Services 130
5.6 Further Reading 136
5.7 Problems 137

6 TRANSMISSION NETWORKS AND ELECTRICITY


MARKETS 141
6.1 Introduction 141
6.2 Decentralized Trading Over a Transmission Network 141
6.2.1 Physical transmission rights 142
6.2.2 Problems with physical transmission rights 143
6 .3 Centralized Trading Over a Transmission Network 148
6.3 .1 Centralized trading in a two-bus system 148
6.3 .2 Centralized trading in a three-bus system 155
6.3 .3 Losses in transmission networks 175
6.3 .4 Mathematical formulation of nodal pricing 181
6.3 .5 Managing transmission risks in a centralized trading system 190
6.4 Further Reading 199
6.5 Problems 200

7 INVESTING IN GENERATION 205


7.1 Introduction 205
7.2 Generation Capacity from an Investor's Perspective 205
7.2 .1 Building new generation capacity 205
7.2 .2 Retiring generation capacity 212
7.2.3 Effect of a cyclical demand 213
7.3 Generation Capacity from the Customers' Perspective 217
7.3 .1 Expansion driven by the market for electrical energy 217
7.3 .2Capacity payments
7.3 .3Capacity market
7.3 .4 Reliability contracts
7.4 Further Reading
7.5 Problems

8 INVESTING IN TRANSMISSION
8.1 Introduction
8.2 The Nature of the Transmission Business
8.3 Cost-based Transmission Expansion
8.3 .1 Setting the level of investment in transmission capacity
8.3 .2 Allocating the cost of transmission
8.4 Value-based Transmission Expansion
8.4 .1 Quantifying the value of transmission
8.4 .2 The transmission demand function
8.4 .3 The transmission supply function
8.4 .4 Optimal transmission capacity
8.4 .5 Balancing the cost of constraints and the cost of investments
8.4 .6 Effect of load fluctuations
8.4 .7 Revenue recovery for suboptimal transmission capacity
8.4 .8 Effect of economies of scale
8.4 .9 A three-bus example
8.4 .10 Concept of reference network
8.4 .11 Generalization
8.5 Further Reading
8.6 Problems

APPENDIX - ANSWERS TO SELECTED PROBLEMS

ABBREVIATIONS AND ACRONYMS

INDEX

Common questions

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Co-optimizing energy and reserve involves simultaneously optimizing both the supply of electricity and the reserve capacity required for contingencies. This approach improves system reliability and efficiency by ensuring the availability of sufficient reserves while minimizing operational costs. It aligns resource dispatch with system needs, reducing the likelihood of shortages and enhancing grid stability, all while providing clear market signals for investment in generation and storage .

Capacity payments provide financial incentives to power providers for maintaining a certain amount of available generation capacity beyond immediate demand. This ensures reliability and encourages private investment in generation infrastructure. From the customers' perspective, these payments can lead to more stable energy prices and improved service reliability. However, they may also result in higher overall costs passed on to consumers if not managed effectively .

In a monopoly model, a single entity controls the entire electricity supply chain, from generation to distribution, leading to limited consumer choice and potentially higher prices due to lack of competition. In contrast, retail competition involves multiple retailers competing to provide electrical energy to consumers, which can lead to better prices, innovation, and customer service, as suppliers have incentives to be efficient and responsive to consumer needs .

Nodal pricing, also known as locational marginal pricing, determines prices at different locations based on the cost of supply, demand, and transmission constraints. This method accounts for losses and congestion in the network, ensuring that the electricity price reflects the true cost of delivering it to a specific location. By doing so, nodal pricing allows market participants to hedge against transmission risks by providing price signals that reflect the scarcity and value of the transmission capacity, thus promoting efficient use of the transmission network .

Hybrid participants, often involved in both producing and consuming electricity, blur the traditional boundaries between roles in the energy market. This model reflects the rise of prosumers, entities that both generate (e.g., via rooftop solar) and consume electricity, offering flexibility and novel revenue streams. It challenges traditional market designs by necessitating new regulatory frameworks and financial products to accommodate these dual roles, thus fostering innovation in energy utilization and grid management .

The managed spot market coordinates real-time electricity supply and demand by adjusting generation and consumption to balance the grid. It interacts with other markets such as bilateral and electricity pools by using information from forward contracts about expected supply and demand, which helps in managing real-time deviations. These interactions ensure system reliability and efficient market operations by facilitating the trading of balancing resources close to real-time .

Physical transmission rights can lead to inefficiencies as they lock transmission capacity for specific paths, potentially resulting in underutilization if path holders do not use or transfer their rights. Moreover, they do not account for network congestion or real-time grid conditions, leading to a mismatch between physical flows and financial rights. This can create barriers to market efficiency and price distortions, hindering optimal usage of the transmission network .

Pareto efficiency is achieved when it is impossible to reallocate resources to make one individual better off without making another worse off. In power systems, achieving Pareto efficiency ensures optimal resource utilization without waste. This concept is crucial for maximizing global welfare, represented by the aggregate benefit across all participants in the market. Any deviation from Pareto efficiency results in a deadweight loss, indicating a loss in economic efficiency where potential gains from trade are not realized .

Investing in generation capacity amid cyclical demand involves predicting demand fluctuations accurately to avoid overcapacity or shortages. Overcapacity leads to unnecessary capital expenditure and maintenance costs, while shortages can result in inability to meet demand, causing possible blackouts or increased reliance on expensive short-term solutions. Investors must balance these risks by aligning capacity expansion with long-term demand trends and incorporating flexible solutions like demand-side management .

The primary difference lies in the timing of the transactions. A spot market involves the immediate buying and selling of electricity for current delivery, focusing on real-time or near-term transactions. In contrast, a futures market involves contracts for the future delivery of electricity, allowing participants to lock in prices for future dates, thereby managing price volatility and risks over time .

Fundamentals of Power System Economics Daniel Kirschen Goran Strbac University ofManchester Institute of Science & Technology
Contents PREFACE xi 1 INTRODUCTION 1 1.1 Why Competition? 1 1.2 Dramatis Personae 2 1.3 Models of Competition 4 1 .3 .1 Model
vw CONTENTS 2.4 .3 Future contracts and futures markets 36 2.4.4 Options 37 2.4.5 Contracts for difference 38 2.4.6 Managing
5 SYSTEM SECURITY AND ANCILLARY SERVICES 105 5.1 Introduction 105 5.2 Describing the Needs 107 5.2 .1 Balancing issues 107 5.
7.3 .2 Capacity payments 7.3 .3 Capacity market 7.3 .4 Reliability contracts 7.4 Further Reading 7.5 Problems 8 INVESTING IN

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