How Wholesale Electricity Prices Are Set
ISO/RTOs use a uniform (or single)
electricity pricing auction in which electricity
generators place bids with an independent market
administrator for a particular time period. The
independent administrator then dispatches the generators
from lowest to highest bids until all power demand is
met. Each generator that is dispatched is then paid the
same price as what was paid to the last unit of
electricity needed to meet total demand.
Uniform clearing electricity pricing auctions are used
for the "spot" (or real-time) markets of all federally
approved and independently run regional electricity
markets. In practice, the spot market is used to serve
only a portion of demand. Like a mutual fund, retail
electricity suppliers serve their customers through a
diverse portfolio of long-, medium- and short-term
contracts, as well as the spot market.
The uniform clearing electricity pricing auction drives
generators to reduce their operating costs so that their
bids can be lower and, hence, will be accepted - the
generators that set the clearing electricity price, and
therefore meet the last increment of demand, earn little
or no contribution to their fixed costs. The lower cost
generators in turn are able to recover some of their
long-term debt and other expenses under this auction
design.
Because the last increment of demand set the clearing
electricity pricing, an explicit price signal to
conserve electricity is established. For certain
customers who can reduce their demand, a price incentive
can be transparently seen.
By contrast, under a pay-as-bid auction design, the
selection process for which generators will run at a
given time is the same as in a uniform clearing
electricity pricing construct with the difference being
that each auction winner is paid exactly what it bid - a
significant distinction.
In a pay-as-bid auction, generators will roll all their
costs into a single bid and attempt to guess what the
highest electricity price selected will be, and then bid
to match it. Inevitably, some lower cost generators will
bid too high - because all generators will be bidding
above their operating costs, market transparency is lost
and the risk of manipulation is raised.
For these simple reasons, economists - and some critics
- agree that uniform clearing price auctions generally
result in lower prices for consumers than pay-as-bid
auctions.
http://www.epsa.org/industry/primer/?fa=prices |
