It Is Time for Power Market Reform to Allow for Retail Customer Participation and Distribution Network Marginal Pricing

Written by Michael C. Caramanis

The introduction of distribution-level marginal prices promises to have transformational impacts on power systems in terms of electricity costs, infrastructure resilience and the wide integration of renewable generation and sustainable new loads such as the electric vehicles. But to achieve the full range of potential benefits, it will be essential to adopt the right pricing structures and market reforms.

The dynamic wholesale power markets that were established in the 1990s relied on the revolutions in computation and communications to improve operational efficiency and economize on capacity investment, while maintaining requirements for reliability and security of supply. With the advent of the smart grid, there is a practical opportunity to extend real-time marginal-cost-based pricing to distribution networks.

In 1996, Andrew Ott and colleagues invented the PJM Interconnection's LMP-based wholesale electricity market. Locational Marginal Prices represent the incremental cost of delivering an additional unit of (real) electric power at high-voltage network nodes. As such, they reflect centralized generation and high-voltage transmission operational costs including maintenance, fuel, congestion and reserves—costs that represent about 65 percent of the total delivered cost of electricity consumed in the United States.

Wholesale electricity markets clear and price real power and reserves, but disregard reactive power and medium- and low-voltage distribution costs. Because in the 1990s transaction costs were (rightly) considered excessive and conditions were seen as uncompetitive in those parts of the power system, LMPs did not and still do not address reactive-power and lower-voltage distribution costs. It remains true that high-voltage, transmission-system reactive power does not travel far, and thus does not have the makings of a competitive market; but conditions are ripe for extension of marginal pricing to distribution-level reactive power and to the congestion costs and line losses in the low- and medium-voltage networks that together account for the other 35 percent of overall electricity costs.

In short, we need to broaden power markets to incorporate loads and resources that are connected in the distribution network and develop new dynamic rates reflecting real-time distribution costs.

Existing markets perform both planning and operational tasks. They consist of day-ahead, hour-ahead/adjustment, five-minute economic dispatch, and five-second regulation markets. These cascaded markets determine real power and reserve clearing prices that balance energy and reserve supply and demand, but limit participants to centralized generators and wholesale load aggregators. In power markets embracing medium- and low-voltage networks, participants will be able to buy real power and sell reserves from and to the high-voltage wholesale market. And since those transactions involve the distribution network, participants also will buy and sell reactive power flowing through that network. That is, they will be charged or debited depending on whether their transactions lead to deterioration or improvement of the voltage-current phase difference that results in higher or lower line losses and hinders or assists voltage control.

Dynamic retail market prices will also reflect participant actions that hasten or delay distribution transformer replacement by burdening or relieving transformers during times of high utilization, as well as the value of incremental distribution line losses caused by their real and reactive power transactions.

Sources of reactive power will expand, bringing substantial efficiencies and cost savings. Traditionally, reactive power compensation has been supplied by just a few generators, usually gas-fired, located close to urban load centers. It is now increasingly provided by trailer-size solid-state dynamic VAR compensators, located at or close to substations. Soon, this picture will change radically with the introduction of many moderately sized (10-50 kVAr) inverter-type power electronic devices embedded in photovoltaic installations and electric vehicles. With minor modifications, a 30 kW solar inverter or the 50 kW inverter/rectifier found in every Prius can be put to dual use. When the sun does not shine or a hybrid vehicle is parked, the inverters can compete to supply reactive power in response to retail market locational price signals. With minor modifications, they can without added cost act as small distributed dynamic-var-compensators that produce or consume reactive power to reduce the flow of reactive power injected into the distribution network at nearby locations by inductive/capacitive loads or the distribution network itself.

Heretofore, because there were so few providers of reactive power, creation of competitive markets was not warranted. The establishment of markets will give larger sets of providers strong incentives to eliminate undesirable voltage-current phase shifts. This will significantly reduce distribution line losses, which account for more than 5 percent of total electricity production and assist with voltage control.

As intermittent sources of energy, like wind and solar, are linked to the grid, there will be a growing need for fast and flexible reserves.These can be used to maintain the power system’s energy balance in real time by absorbing positive as well as negative fluctuations in renewable generation. These fast reserves—known as Regulation Service Reserves (RSRs)—are procured in the hour-ahead or day-ahead markets but are actually utilized to track ISO regulation signals issued every 5 seconds. It has been estimated that a 30 percent increase in renewable generation will imply a three- to four-fold increase in RSRs. Since RSRs clear today at prices comparable to energy clearing prices, to increase their supply under existing conditions will pose a significant barrier to renewable generation expansion. But higher RSR costs may be avoidable if the reserves can be obtained from flexible building loads, and EV battery charging. This synergy can be achieved by efficient market price signals that provide flexible loads with the requisite incentives to consume energy when it is abundant and supply RSRs when they are needed. Concurrent adoption of EVs and renewable generation to fuel them will yield the dual benefit of reducing both carbon dioxide emissions as well as reliance on imported oil.

To realize the synergies and benefits outlined above, systems and control theory must be appropriately employed. Spatio-temporally varying dynamic price incentives must be estimated in a price discovery mode that is guaranteed to be socially efficient and stable. Such a system must rely on information about market participant preferences that the revised market rules allow participants to express. Real-time participant behavior can then be driven by appropriate distributed intelligence imbedded in load devices.

Discussion of retail competition is not new. The late MIT professor Fred Schweppe famously laid out his vision of retail competition in the late 1970s with amazing clairvoyance, for example in an article that appeared in the July 1978 issue of IEEE Spectrum magazine. Participation of small consumers in the power markets has been under discussion since the mid-nineties, and retail suppliers already are actively claiming market share. Energy service companies such as EnerNOC are aggregating loads to provide demand-response-based operating reserves to ISOs around the country. Nevertheless, retail rates still reflect average costs rather than marginal costs, and are subject to cost regulation by state regulators. Generally, retail dynamic pricing is for all practical purposes non-existent.

So what makes us believe that a sea change is in the offing? The basis of our optimism is the low cost and availability of the needed cyber technology and the compelling economic efficiency promise that resides in the synergies of new flexible and power-electronics-bearing loads with economically competitive renewable generation.




Michael C. Caramanis is a professor of mechanical and systems engineering at Boston University. He teaches in the areas of stochastic control, supply chains and power markets, and has consulted on power market design in the United States, United Kingdom and Italy. His current research concerns sustainable advanced building design and operation, and the extension of power markets to provide access to distributed loads and resources while incorporating distribution/retail costs and congestion. An IEEE member, he earned a BS degree in chemical engineering at Stanford and an MS and PhD in engineering at Harvard.