Locational Prices
Energy plus congestion plus losses, and why the same megawatt-hour is worth different amounts a few miles apart.
Two substations forty miles apart, connected by wires, in the same market, under the same operator, at the same instant. One clears at 32 dollars a megawatt-hour. The other clears at 480. Nothing has broken, nobody is being cheated, and both numbers are correct.
This is the property that separates electricity from every other commodity in this series, and it follows from Chapter 3. A market that treated the grid as a single point, where any generator could serve any load, would be assuming what engineers call a copper plate. The grid is a finite network with lines that carry a limited amount of power, and when one of those limits is reached, the cheap generation on one side of it stops being available to the demand on the other.
Three components
The price at a location, its locational marginal price, is the cost of serving one more megawatt-hour of demand at that specific point, given every constraint the system is currently respecting. It decomposes into three parts.
Table 10-1: What a locational price is made of
| Component | What it reflects | Varies by location? |
|---|---|---|
| Energy | The system-wide marginal cost of production, the number Chapter 8 described | No. One value for the whole system |
| Congestion | The cost of transmission limits forcing a more expensive dispatch | Yes, and it is the large term |
| Losses | Energy dissipated as heat getting power to this point | Yes, but usually small |
Losses are intuitive. Moving power along a conductor wastes some of it, so serving a megawatt-hour far from generation requires slightly more than a megawatt-hour to be produced, and distant locations price a little higher for that reason alone.
Congestion is where the interesting behaviour is. When a transmission limit binds, the dispatch algorithm can no longer choose the cheapest generator. It has to back down cheap generation on the constrained side and start something more expensive on the other side. The extra cost of that substitution, per additional megawatt of demand at a given point, is the congestion component of that point's price.
The shadow price, and why a constraint has a value
Every binding constraint in the dispatch has a shadow price: the amount the total cost of serving the system would fall if that limit were relaxed by one megawatt. A line running at its limit through a tight evening might have a shadow price of several hundred dollars, meaning one more megawatt of capacity on that specific line would save the system that much in that interval.
Shadow prices are the mechanism by which a physical limit becomes a financial quantity, and they produce results that look wrong until the cause is clear.
A congestion component can be negative, so that a node prices below the system energy component, which happens where adding demand relieves a constraint rather than worsening it. A price can exceed the offer of every generator running, because serving another megawatt at a constrained location may require redispatching several machines at once. And prices at two nodes on the same short line can differ enormously while nothing physically distinguishes the locations except which side of a limit they sit on.
Nodes, hubs and zones
A nodal market computes this at every point where the network model has a bus. PJM clears roughly 11,000 of them, recomputed every five minutes in real time. Chapter 15 sets that against Europe, which clears about 40 bidding zones for an entire continent, and the comparison is the sharpest single difference between the two systems.
Eleven thousand prices are unusable as a trading screen, so markets aggregate. Generators settle at their own node, since that is where they inject and where their effect on constraints is real. Load usually settles at a zonal average, on the reasoning that a household cannot respond to a nodal price and should not carry the risk of the substation it happens to sit near. Trading concentrates at hubs, which are defined baskets of nodes that exist to give a liquid reference point, in the same way that a crude benchmark exists so that cargoes with no market of their own can price against something.
Congestion rent, and where it goes
When a constraint binds, the operator collects more from load than it pays to generation, because load is paying the higher constrained price while generation behind the constraint is receiving the lower one. That surplus is congestion rent, and it can be very large.
The operator does not keep it. In a well-formed nodal market the rent funds financial transmission rights, instruments that pay their holder the difference in price between two points. A generator whose output is stuck behind a constraint can buy the right between its node and a hub, and be made whole for the discount it suffers. The congestion rent collected from the physical market is what pays those claims, which is why the two exist as a matched pair. Chapter 22 takes up the instruments.
Basis is the risk that ruins contracts
The practical consequence for anyone signing a long-term contract is that the hub price and the node price are different numbers, and their difference is neither stable nor predictable.
A solar developer signs a power purchase agreement referencing a hub. The project settles at its own node. If new generation is built nearby, or a line is derated, or load patterns shift, the node can drift persistently below the hub. The developer is then delivering energy worth less than the contract assumes and paying the difference. Basis risk of this kind has damaged more renewable projects than construction cost overruns, and it exists because Chapter 3 is true: the wires are finite and the price knows it.
Which is also the answer to a question that recurs whenever electricity prices are compared across regions. There is no single price for power in the United States, or in Texas, or in a single ISO, in the way that there is a price for WTI. There is a price at a point, at an instant, and the difference between two such prices measures a wire.