The Value and Importance of Independent System Operators

1. The Value and Importance of Independent System Operators  Richard O’Neill Chief Economic Advisor Federal Energy Regulation Commission richard.oneill@ferc.gov System operators and electricity markets the experience of SO – CDO for UES and international practice September 19-20, 2007 Moscow, Russia Views expressed are not necessarily those of the Commission

2. What is at stake?

3. for nuclear plants

4. Policy choices • Cost of service regulation isn’t working well • Excess capacity • High costs • Let’s try competition • Market-based regulation • Properly shifts risk • Stronger incentives

5. What changed? • Technology has eliminated some market failures • Generator size small compared to market • vertical integration not required for communication • What is at stake?

6. Computational considerations • 1996: LMP in NZ • 300 nodes • No transmission constraints • 1990s: linear programs improved • 103 in hardware • 103 in software • 2000s: mixed integer programs improved by 103 • 2006: 30000 nodes • 10000+ transmission constraints • 1000 generators with n-part bids • MIP introduced in DAM

7. The goal of market-based design is to: • Ensure reliable operation • Ensure just and reasonable prices • produce efficient short run market outcomes • encourage long run efficient investments • Eliminate barriers to competition, entry and exit

8. Competition Issues • Vertical market power is the most important • entry • artificial congestion • Horizontal market power is handled by • Entry • contracts

9. What is needed for efficiency? • good information and market design • mitigation of market power • recognition of how electricity works • understand the choices • free market • market with market rules • administrative rules

10. ISO Principles • Non-discriminatory governance • no financial interest in market • efficient use of grid • short-term reliability • relieve tx constraints • incentives to be efficient • open information system

11. ISO Ancillary service markets • System operation • balancing • Regulation • Spinning Reserves • Non-Spinning Reserves • Reactive power

12. Paradigm Change Transitioning from planning and dispatch to auction and market power mitigation models

13. Goals of Auction Markets • Efficiency • maximize consumer and producer surplus • Often an objective of the regulator • Reduce Transactions Costs of achieving efficiency • Incentives to • bid and invest ‘competitively’ • innovate

14. Failed market designs • Zonal markets (Cal, PJM, NE, UK) • Sequential markets for energy and anc services • One settlement systems • Infeasible markets (Cal PX and UK) • Ignore non-convexities (start-up and no-load) • Ignore market power • all ended in administrative intervention

15. Market Design that works • Locational • bid based • security constrained • Financial transmission rights • Market power mitigation • Freedom of ‘bilateral’ contracts • Long term contracting • Short-term contracting

16. A spot market design that works • Day-ahead (24 hours): • efficiently schedule generation load and ancillary services • Within the limits of generators and transmission • Real-time (5 Minutes): • efficiently dispatch generation load and ancillary services • Within the limits of generators and transmission • balancing market

17. Pre-day-ahead auction markets • Generation Capacity • ensure generation adequacy • Call option in spot market • Transmission rights (FTRs) • hedge transmission congestion costs • Pay difference in LMPs • Options and obligations

18. End-use markets • Vertical demand curve in ISO markets • Consumers receive very weak price signals • No real time meter • No real time price • On a hot summer day • wholesale price = $1000/MWH • Retail price = $100/MWH • Solution: demand side bidding

19. ISOs, Efficiency and green power • solar and wind need real-time market to realize value • Wind has a real-time market • solar’s highest output is during peak • hydro: value as an ancillary service

22. Locational Marginal Pricing • LMP: nodal market clearing price • the value of an incremental MW • at a location (node) • FMP (Flowgate Marginal Price) • the value of the incremental MW of transmission capacity • on a flowgate (line or lines) • based on supply and demand bids • forward markets hedging • Financially: liquidated • Physically: build a plant and/or transmission

23. Example LMP = 20 $/MWh DEMAND = 100 MW LMP = 15 $/MWh FMP = 5 $/MWh 1 2 Constrained Interface 75 MW MC = 20 $/MWh CAP = 110 MW MC = 15 $/MWh CAP = 120 MW What is output of Gen A? 75 MWh Gen B? 25 MWh What is the value of the transmission line? $375 What is the value of an additional unit of transmission ? $5

24. Market Monitoring • analyze market design • analyze market power • Screen • Investigate • mitigate • penalties

25. Ex ante mitigation in ISO • Does the generator appear to be withholding? • physical withholding: not available at rated capacity. Why? • good reason: scheduled maintenance or forced outage • economic withholding: bids above marginal costs

26. Results to date: improvements in • More competition • Lower heat rates • Higher capacity factors • Lower labor costs • Higher profits of generators • Higher trading efficiency

29. Benefits of better modeling • Measured in billions • Benefit/cost can be over 250 • Examples • MIP • CCCT modeling • Topology estimators • Reactive power modeling • Transmission dispatch

30. value of smart grid improvements

31. Research questions • Decomposition • Real/reactive • Time • Market participant • Good approximations • Linearizations • convex • Avoiding local optima • Nonlinear prices v linear prices • Improved market power analysis • More rational market power mitigation

32. “A new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents eventually die, and a new generation grows up that is familiar with it.” Max Planck, “Scientific Autobiography and Other Papers”