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Engineering Smart Retail Electricity Markets

Advanced metering infrastructure is a cornerstone of future grids, but the smart grid encompasses much more than the most frequently mentioned features connected with AMI such as increased communication capabilities, monitored infrastructure, improved fault recovery and self-healing capabilities. It also involves completely new processes and schemes to improve economic efficiency in coordinating the interests of all different stakeholders. Through the establishment of well-designed markets on all levels, and on most time horizons, the power system can become more efficient and greener, as well as smarter.

The electrical power system of today is mainly controlled through the supply side, but this paradigm is expected to change: first, with the increasing relevance of fluctuating generation from renewable energy sources; and second, due to increased communication capabilities in the smart grid. Fluctuating renewable generators need to be complemented with a flexible demand side. Already today heating and cooling systems—such as residential hot water boilers and large-scale refrigerated warehouses—offer significant load flexibility that helps to adapt to limitations of intermittent generation. Furthermore, electric mobility is expected to become another major source of load flexibility.

To leverage the full potential of these infrastructure capabilities, appropriate coordination mechanisms need to be established. There is general agreement indeed that a smart grid needs to feature some sort of marketplace or retail trading platform, and most major smart grid demonstrations projects feature local energy markets. For example, this is true of the Olympic Peninsula project in the United States and of Germany's e-Energy model regions.

The goal of the Peninsula project has been to increase electrical and economic efficiency of the power system in a field test by adding information and communication technology to the distribution grid and a market as a top layer for economic coordination of different stakeholders' preferences. The e-Energy program's goal is to ensure more effective utilization of the existing electricity supply infrastructure, expand the use of renewable energy resources and reduce carbon dioxide emissions through the use of information technology.

In the past decade we have learned a great deal about how to build a smart grid infrastructure, but experiences with local energy markets have, so far, been limited. Given their central role in the future, market design is of paramount importance. Market engineering provides a structured approach based in economic principles for designing market platforms. While acknowledging the regulatory environment, the market engineering process demands a thorough understanding of market institutions, the objects to be traded and the participants. Furthermore, proper assessment of a market's viability requires measuring and evaluating market outcomes.

By applying market engineering principles to smart grid markets, we can identify key issues that need to be understood and points that must be remembered in establishing efficient and robust trading platforms at the local level.

Transaction Object. In order to manage the complexity of both trading agents as well as the market platform, new kinds of tradable energy services that "package" flexibility will play a major role in the future. For example, this flexibility could be expressed in terms of power/energy flexibility over time and associated maximum ramping rates, lead times before changes in consumption may take effect, or other attributes of energy usage.

Market microstructure. Load curtailment programs have been the precursor for more sophisticated demand-side control and coordination paradigms. In the future, serious efforts will have to go into the market microstructure. This will require the specification of a bidding language that allows compact expression of market participants' preferences. Furthermore, appropriate allocation and payment rules need to be introduced. To facilitate the large-scale impact of smart grid technologies on actual system outcome, it will be important to adequately reward customers who provide flexibility by establishing incentives.

Infrastructure. Following the old saying that one can only control what one can measure, widespread adoption of advanced metering infrastructure coupled with temporally and spatially differentiated price signals will be key to achieving a responsive power system based on smart grid technologies. The rollout of smart grid components will allow for more efficient and granular coordination of demand and supply.

Business structure. It is currently debated who should operate such future retail energy markets, private companies or regulated grid operators. It remains to be seen, in fact, whether running this marketplace can be done profitably. Moreover, other market roles, such as aggregators or energy brokers, may emerge. By taking over energy management tasks from dispersed clients, such agents may enable substantial load flexibility.

Customer behavior. A proper assessment of smart grid potentials requires a better understanding of customers' behavior in power markets. We identify two key factors for describing retail customer behavior: cost efficiency and behavioral aspects. Assuming rational customers within an economic ecosystem, their actions will, to some extent, be driven by monetary incentives. However, individual behavior is also governed by additional non-monetary objectives ranging from personal convenience to a desire for sustainable behavior.

Market outcome. Having established a marketplace it remains to be seen whether and how well the market objectives are achieved. This market quality has to be evaluated along different dimensions such as dispatch efficiency, load flexibility, trading activity, liquidity and price discovery.

We currently see a sort of a chicken-egg dilemma with respect to smart grid investments: Local energy marketplaces cannot evolve without the necessary metering and communication infrastructure in place; but at the same time, grid operators remain hesitant to roll out the costly infrastructure because the business case remains hazy. To cut the Gordian knot and make our grids ready for the future, grid operators and regulators will have to work together in finding and establishing appropriate incentive mechanisms for smart grid investments. Another fundamental requirement for a viable marketplace is stakeholders' trust in the platform as related to terms of security and privacy, as well as the aforementioned monetary and non-monetary factors.

We see the smart grid as both a collection of advanced networked metering devices as well as a platform that facilitates the economic exchange of so-far untapped load flexibility. The development of local market mechanisms will strengthen the power system and pave the way towards a more resilient and sustainable power system.


  • Christof WeinhardtChristof Weinhardt has headed the Institute of Information Management and Systems at the Karlsruhe Institute of Technology (KIT) since 2000. He holds a master's degree in industrial engineering and management and a Ph.D. in Economics, both from KIT. Before joining the institute he held full professorships at the universities of Giessen and Bielefeld. His research focuses on the design and analysis of new markets in the finance, energy and services industry.

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About the Smart Grid Newsletter

A monthly publication, the IEEE Smart Grid Newsletter features practical and timely technical information and forward-looking commentary on smart grid developments and deployments around the world. Designed to foster greater understanding and collaboration between diverse stakeholders, the newsletter brings together experts, thought-leaders, and decision-makers to exchange information and discuss issues affecting the evolution of the smart grid.


Michael C. CaramanisMichael C. Caramanis is a professor of mechanical and systems engineering at Boston University.
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Christof WeinhardtChristof Weinhardt has headed the Institute of Information Management and Systems at the Karlsruhe Institute of Technology (KIT)...
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Gelareh TabanGelareh Taban is a security engineer working in Silicon Valley. She received her M.S. and Ph.D. degrees from the University of Maryland...
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Alvaro A. CárdenasAlvaro A. Cárdenas, an IEEE member, is a research staff engineer at Fujitsu Laboratories of America.
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