Energy price formation in wholesale electricity markets

Introduction

Working Group C5.28^[1] is examining how energy prices are formed in the various electricity markets around the world — with a focus on wholesale energy markets. The group has gathered information about pricing mechanisms as they exist today and is examining if these mechanisms are working as desired. For example:

• are energy markets providing incentives for desired operational behaviors?
• Are out-of-market (uplift, make-whole and parallel) payments impacting desired price signals?
• Are there attributes not currently valued in energy markets – like flexibility or environmental externalities – that should be considered in price formation?

After evaluating the current energy pricing landscape, the Working Group will discuss potential enhancements that could more accurately reflect the true cost of wholesale energy.

Survey

The Working Group will be publishing its results later this year and this paper provides their early findings.

The Working Group developed a survey, which has received seventeen responses from countries or markets (where there is more than one market in a country). 

The seventeen countries or markets that responded to the survey are:

Market Models and Price Formation

The market models of the responding countries tend to fall into three general categories:

1. Locational Marginal Pricing (LMP) models
2. Zonally priced models
3. Uniform pricing models

The survey sought to identify the pricing methodology for the market that is most closely tied to real-time system operations. This is different by each country/region. For example, some countries only have real-time markets, others only have day-ahead markets, and some have both. 

LMP Models - Russia, Australia (subject to change), Philippines, United States (ERCOT, MISO NYISO, PJM), Chile

The LMP-style models are generally characterized by real-time energy markets that are closely tied to real-time dispatch. In these models, security constraints within the network itself are modeled in both the dispatch and pricing and as a result these markets have nodal prices that reflect the cost of energy and the impact of network limitations.

Some things that differ across these models are the structure of supply offers that are used to derive prices. Specifically, US market models that utilize LMP only include a portion of generator costs in the calculation of the price. This can lead to the need to uplift payments to ensure the markets are not confiscatory and further parallel payments such as capacity payments. This can be contrasted with models such as Australia where supply offers represent the “all-in” cost of a resource and therefore there is less of a need for uplift payments or parallel payments.

More information is being gathered on these types of models.

Zonally Priced Models – Spain, Portugal, Estonia, France, Netherlands, Norway

Zonally priced models are markets that are implemented by various countries in the EU. Responses for these market models focus on Day-ahead Market pricing, as real-time trading in these markets does not result in price changes. In the EU model, network constraints are modeled and optimized but only between countries rather than within them. Therefore, each country has a uniform price but each country’s price may be different from another country’s.

Prices in these models are derived by bids and offers submitted by market participants that are optimized in a manner that maximizes overall welfare while reflecting the inter-tie constraints between each country.

Because these models do not tie market prices directly to the real-time operation of the market, the cost of actions taken by the Transmission System Operator to maintain real-time reliability are recovered through uplift payments from participants.

Uniform Pricing Models – Brazil (subject to change), Colombia, Gulf Coast Cooperation Council, India, Japan, Canada (Ontario)

This group of models contains several respondents whose country or region has one single uniform price. The market-clearing mechanisms in these models differ by region and more information is currently being gathered on the specifics of each model at this time.

Because these models do not tie market prices directly to the real-time operation of the market, the cost of actions taken by the Transmission System Operator to maintain real-time reliability are recovered through uplift payments from participants.

Parallel Payments

The paper will also explore parallel payments made in the various countries and regions. These payments include various payments made to market participants such as capacity payments to support market reliability, reserve payments to participants to provide reserves to the market and uplift payments which may be for the impact of constraints on participants or for other reasons.  The Working Group is examining the range of these payments, their purpose and their impact on the operation of the markets.

While more information is being gathered about parallel payments at this time, the Working Group believe that there is a linkage between the philosophy behind the price formation methodology and the need for parallel payments.

Market Performance and Drivers of Change

Finally, the paper will look forward at potential drivers of future change in the price formation processes in each of the countries or markets. The survey results provided a range of potential drivers.  Several common ones include:

• Carbon abatement policies
• Integration of nascent technologies including electric vehicles and storage
• Addition of new grid services into the co-optimized energy market
• Demand-side participation changes
• Changes driven directly by the regulator

Final Thoughts

A key finding from the analysis of the surveys to-date is that successful markets can be designed in a variety of ways and that the price formation methodology is dependent on the priorities of the regions. LMP-based markets tend to focus on conveying the physics of the system and cost of electricity through their pricing whereas zonal and uniformed priced models tend to have broader pricing regions to facilitate trading between market participants.

Both models can and have been implemented effectively depending on the priorities of the region.

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Thumbnail credit: Photo by Federico Beccari on Unsplash