Merits and Limitations of Economic Dispatch Models

Fundamental electricity market models aim to describe the electricity price by the interplay between demand and supply. Necessary ingredients are data on the plants, scenarios for the input prices, and electricity demand. With the help of numerical optimization techniques or more precisely constrained optimization, the electricity prices can be explained in a fundamental way, i.e., without having to calibrate a model to the current market situation as it is done for example with statistical price models or classical finance models. Fundamental models are heavily applied by universities, regulators, as well as consulting companies, mostly to predict the effect of fundamental market changes. These fundamental shifts include additional electricity production from renewable sources, or fluctuating prices for primary energy or carbon emission certificates. The big advantage of fundamental electricity market models is that such changes can easily be integrated into the models by varying the aforementioned input parameters. Therefore, fundamental modeling of electricity prices have become state-of-the-art in the discipline of energy economics. Many authors use it as a tool to tackle policy question. However, a critical evaluation of the strength and limitations of this tool is underrepresented in the academic literature. The goal of this project is to discuss the limiting aspects of fundamental electricity price models. Furthermore, I am interested in sensitivity analysis to find the optimal degree of aggregation and the optimal time horizon for such models.

Supplier market power in wholesale electricity markets has been an issue from the beginning of the electricity market liberalization. While market power in single zone markets is well understood, market power is less understood in locational markets, where firms own multiple generation technologies across space. We derive a general methodology for measuring the ability of suppliers that own generation units at multiple locations in the transmission grid to exercise unilateral market power in a locational pricing market. We then demonstrate the usefulness of this methodology for: (1) modeling expected profit-maximizing offer behavior by a supplier, (2) quantifying the impact of a large supplier divesting itself of fixed quantity of generation capacity, and (3) developing own-location and cross-location measures of a supplier's ability to exercise locational market power. Furthermore, we develop a stochastic equilibrium model of competition between firms setting locational quantities against the distribution of residual demand hyper-surfaces and use it to determine the equilibrium implications of different locational capacity divestment scenarios. We apply this general methodology to the locational Italian wholesale electricity market and the results contributed to the field by extending classical measures to estimate market power potential of strategic firms to locational markets. Unlike in the United States, Europe deploys a zonal electricity market model that ignores many of the physical aspects of the electricity grid as well as the operational characteristics of conventional power plants. However, because in real-time locational supply must be equal to locational demand plus net-imports, the transmission grid operator might be forced to change the schedules from generation units that have been accepted in the market but would violate system constraints. These correction mechanisms can be strategically exploited by selling energy to the market that is likely to be not needed in real-time and by withholding capacity from the market that is likely to be needed in real-time. These "perverse incentives" have led to a change in the United States wholesale market design in the early/mid 2000s. We show that these incentives determine unit-level offer curves submitted to the market and lead to inefficiencies. Market power in locational electricity markets can severely harm consumers that is why effectively all US wholesale electricity markets have automatic market power mitigation tools incorporated into the market-clearing. We review these mechanisms and discuss challenges of these tools in an environment with more renewable energy sources being online.