In this post I am going to discuss how the market has substituted the power plant dispatch, and which mechanisms have been designed so that the market of electricity can provide a feasible real world solution. (Spoiler: there’s still some dispatch optimization being done)
Traditionally, power plants were dispatched so that the overall cost of production was the lowest. This is known as “economic dispatch” and it is an optimization problem that minimizes the cost of satisfying a certain demand with a combination of power plants, while keeping the grid loses to the lowest possible values and avoiding the violations in voltage and loading of the electrical grid components. In my opinion this is the best possible way to operate a power system, since the lowest electricity cost is guaranteed by the mathematical method. Meaning the consumer will pay the minimum possible cost for the given available set of power plants, for which the operational costs have been computed correctly.
Here lies the problem. Given a set of power plants and being those operated at the minimal system cost, why would an electric company invest in more efficient and cleaner technologies? The answer is that they would not invest at all in cleaner technologies unless there is a clear economic benefit such as a feed in tariff.
The market mechanisms are introduced to foster the improvement of the existing power plants and to promote cheaper technologies such as wind and lately solar. So, what is the market? and how can it be applied to the dispatch of power plants?
For every hour or every 15 minutes or any other interval considered by the market for the day ahead, every power plant bids an amount of energy that it can generate at their marginal cost (cost that covers their operation plus a benefit). Low operational cost technologies such as wind and solar can offer their energy at a very low price, whereas very high operational cost technologies such as gas turbines must offer their energy at a higher price. For the same auction, the energy retail companies offer to buy amounts of energy for certain prices. Those that “desperately” need to have a certain amount of energy offer the highest price (knowing that the final price would likely be lower than their bid) and those companies that have flexibility and can afford not to buy the energy in this auction, offer the lowest price.
The generator bids and the retail bids are added up in the respective generation and demand bid curves, and then the crossing point determines the matched demand and its price.
Does the market matched demand have to be the system actual demand? Of course not. It can be anything. In fact every day there is a more or less important deviation of the market matched energy with the actual system demand. Furthermore, the system actual demand of the day ahead for which the market solution is being computed is unknown, so there is always uncertainty.
I will call the market crossing point, the market solution to the system dispatch. In a market with hourly intervals the market solution is composed by 24 values. Of course this solution does not minimize anything, in a perfect competition market it would, but the electric system cannot be in perfect competition because I, as consumer cannot choose where to get the electrons from. Because of this, the transmission system operator (TSO) needs to run an optimal power flow (an optimization problem much like the optimal dispatch) to check whether the market solution makes any physical sense. Imagine the following:
There is a country with an electricity market. In this country a group of very talented people, develop a technology that can offer infinite power at zero cost. Therefore these people could offer all the country energy for 1 cent of Euro, and it would still be profitable. In the market, this technology would leave out all the possible competitors, being the final market solution that all the country energy is generated by the infinite power plant at the cost of 1Euro cent.
This would imply that all the country energy would come from a single point, and this would cause massive voltage violations and overloads in the existing infrastructure, since the infrastructure is not as cutting edge as the new power plant.
The TSO has the duty of checking that the market solutions are feasible, moreover, they must ensure that in real time, the actual generation matches the demand exactly. That is why they must complement the market solution mismatch with other services.
The market mechanisms only looks at how to satisfy a demand at the minimum cost (given the bids, which have little to do with the real cost of the system), this is why the TSO must ensure that the economic solution also satisfies the real world constraints. Again the advantage of the market is that it allows more diverse players than the traditional scheme.
Any particular power plant is retributed by the amount of energy that it managed to sell on the market, plus the amount of ancillary services energy that it managed to sell to the TSO. I’ll discuss how to optimize these revenues for a power plant in another post.
Does the market hypothesis hold?
The efficient market hypothesis as a price optimizator only works if there is a large number of market players. Why?
If there is a limited number of market players, those will agree prices, or artificially put power plants in maintenance in order to benefit from the market demand. Therefore the market prices will not be the real prices but artificial ones.
On the other hand if there are many players offering and demanding energy, it is much more difficult that they agree prices with enough time. Furthermore, if there are more players the demand mismatch and the TSO corrections are likely to be lower since the market generation solution will be more distributed, and probably closer to the load points.
The more players in the game, the more efficient the market is. The opposite is also true.
The proper planning of a power system will always produce a better price than any market mechanism, because it would minimize the waste of energy, and would maximize the performance of economic investments system wise. This solution is philosophically closer to socialism, where the individuals are surrogated to the system and there is no freedom to act or innovate (Our infinite power plant would not be accepted).
The market mechanism allows freedom and diversity, but requires the existence of many actors maximizing their own benefit without looking at other actors, to work. Still it will not minimize the energy waste or the energy price.