FEATURE ARTICLE
Reengineering the Electric Grid
Deregulation places new demands on one of the world's largest engineered structures—and presents new opportunities for educated consumers
Thomas Overbye
Market Power Assessment
One of the key goals of deregulation is to obtain lower prices through competition. However, as the grid is deregulated, there are significant concerns that the benefits gained from breaking up the vertical market power of a traditional utility may be lost through the establishment of horizontal market power, particularly in generation markets. Market power is the ability of a particular seller or group of sellers to maintain prices profitably above competitive levels for a significant period of time, and it is the antithesis of competition.
As Figures 7 and 8 showed, limitations on any part of the transmission system can segment large portions of the generation market. The same limitations can give unusual market power to a particular generator. Imagine that a particular bus is joined to the rest of the electric system by a single transmission line. When that line is congested, any additional demand can be handled only by the generator on the local bus. Thus, when the customers turn on their air conditioners on a hot summer day—creating an additional demand—they have no choice but to pay the price set by the local generator. That generator has market power.
Even when the local bus is connected to the rest of the network by several lines, it is easy to devise scenarios where the local generator can gain market power when one of them is congested. This fact creates the possibility that owners of groups of generators could deliberately induce congestion for strategic purposes.
Small generators strategically placed can suddenly have tremendous market power. Under high-load conditions, a single small generator in the western part of New York state producing 85 megawatts—a tiny piece of the state's 25,000-megawatt generating capacity—has a tremendous amount of market power in its region. If that generator were turned off, the marginal price of electricity would spike locally from $25 per megawatt-hour to over $100. Such a large rise in the locational marginal prices comes about because other generators must be dispatched nonoptimally to cope with the congestion.
Under these loading conditions, the small generator in New York has become what is known as a "must-run" generator. A must-run generator is simply one that, for certain system load conditions, must be dispatched within a certain range to prevent transmission-line overloads or other system problems. Keeping in mind that the transmission grid was originally designed to meet the needs of a vertically integrated utility moving power from its generators to its loads, the presence of numerous must-run units is not surprising. Must-run generators exist in most electricity markets.
Must-run generators can be dealt with in several ways, none of which is perfect. One approach is to negotiate long-term contracts for their energy output. This approach works well if a relatively small number of generators fall into this category; however, if there are too many the market is no longer competitive. The long-term contract approach also does not address the issue that almost any generator, during an unexpected power outage, can become temporarily must-run.
To remedy these problems, the ISO can dynamically determine must-run generators. The bids for these generators are then capped to values negotiated in advance. But then the difficulty lies in determining which generators are must-run. If a single entity owns a large portion of the generation within a particular region, it may be able to subtly increase prices above competitive levels. Evidence from simulations suggests that in such situations exploitation of market power by the participants could be expected. On the other hand, the end users of power are now direct players with influence in the market as well.
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