Locational Marginal Pricing: When and Why Not?

Abstract

This study establishes that Locational Marginal Pricing (LMP) is conceptually problematic for grid-supported centrally-managed wholesale power markets transitioning to decarbonized grid operations with increasingly diverse participants, hence with increasingly uncertain and volatile net loads. LMP assigns a common per-unit price LMP(b,T) ($/MWh) to each “next” unit (MWh) of grid-delivered energy, conditional on delivery location b and delivery period T. However, the valuation of this “next” unit by a market participant or system operator will typically depend strongly on the specific dynamic attributes of the path of power injections and/or withdrawals (MW) used to implement the delivery of this “next” unit at b during T. One option is to muddle through, forcing market participants and system operators to express benefit and cost valuations for “next” units of grid-delivered energy (MWh) in per-unit form ($/MWh) without regard for the true benefits and costs of flexible dynamic power delivery. Another option, illustrated in this study, is to explore alternative conceptually-coherent product definitions, settlement rules, and bid/offer contract formulations that permit electric power grids to function efficiently as flexibility-support insurance mechanisms enabling just-in-time power deliveries to meet just-in-time customer power demands and grid reliability requirements.