Preface xv
Nomenclature xvii
PART I INTRODUCTION TO ECONOMIC CONCEPTS 1
1 Introduction to Micro-economics 3
1.1 Economic Objectives 3
1.2 Introduction to Constrained Optimisation 5
1.3 Demand and Consumers? Surplus 6
1.3.1 The Short-Run Decision of the Customer 7
1.3.2 The Value or Utility Function 7
1.3.3 The Demand Curve for a Price-Taking Customer Facing a
Simple Price 7
1.4 Supply and Producers? Surplus 10
1.4.1 The Cost Function 11
1.4.2 The Supply Curve for a Price-Taking Firm Facing a Simple
Price 11
1.5 Achieving Optimal Short-Run Outcomes Using Competitive
Markets 14
1.5.1 The Short-Run Welfare Maximum 14
1.5.2 An Autonomous Market Process 15
1.6 Smart Markets 17
1.6.1 Smart Markets and Generic Constraints 17
1.6.2 A Smart Market Process 18
1.7 Longer-Run Decisions by Producers and Consumers 20
1.7.1 Investment in Productive Capacity 20
1.8 Monopoly 22
1.8.1 The Dominant Firm ? Competitive Fringe Structure
24
1.8.2 Monopoly and Price Regulation 25
1.9 Oligopoly 26
1.9.1 Cournot Oligopoly 27
1.9.2 Repeated Games 27
1.10 Summary 28
Questions 29
Further Reading 30
PART II INTRODUCTION TO ELECTRICITY NETWORKS AND ELECTRICITY
MARKETS 31
2 Introduction to Electric Power Systems 33
2.1 DC Circuit Concepts 33
2.1.1 Energy, Watts and Power 34
2.1.2 Losses 35
2.2 AC Circuit Concepts 36
2.3 Reactive Power 38
2.3.1 Mathematics of Reactive Power 40
2.3.2 Control of Reactive Power 42
2.3.3 Ohm?s Law on AC Circuits 43
2.3.4 Three-Phase Power 44
2.4 The Elements of an Electric Power System 45
2.5 Electricity Generation 46
2.5.1 The Key Characteristics of Electricity Generators 49
2.6 Electricity Transmission and Distribution Networks 52
2.6.1 Transmission Networks 54
2.6.2 Distribution Networks 57
2.6.3 Competition and Regulation 59
2.7 Physical Limits on Networks 60
2.7.1 Thermal Limits 61
2.7.2 Voltage Stability Limits 64
2.7.3 Dynamic and Transient Stability Limits 64
2.8 Electricity Consumption 66
2.9 Does it Make Sense to Distinguish Electricity Producers and
Consumers? 67
2.9.1 The Service Provided by the Electric Power Industry 69
2.10 Summary 70
Questions 71
Further Reading 72
3 Electricity Industry Market Structure and Competition
73
3.1 Tasks Performed in an Efficient Electricity Industry 73
3.1.1 Short-Term Tasks 73
3.1.2 Risk-Management Tasks 75
3.1.3 Long-Term Tasks 75
3.2 Electricity Industry Reforms 76
3.2.1 Market-Orientated Reforms of the Late Twentieth Century
77
3.3 Approaches to Reform of the Electricity Industry 79
3.4 Other Key Roles in a Market-Orientated Electric Power System
81
3.5 An Overview of Liberalised Electricity Markets 82
3.6 An Overview of the Australian National Electricity Market
85
3.6.1 Assessment of the NEM 87
3.7 The Pros and Cons of Electricity Market Reform 88
3.8 Summary 89
Questions 90
Further Reading 90
PART III OPTIMAL DISPATCH: THE EFFICIENT USE OF GENERATION,
CONSUMPTION AND NETWORK RESOURCES 91
4 Efficient Short-Term Operation of an Electricity Industry
with no Network Constraints 93
4.1 The Cost of Generation 93
4.2 Simple Stylised Representation of a Generator 96
4.3 Optimal Dispatch of Generation with Inelastic Demand 97
4.3.1 Optimal Least Cost Dispatch of Generation Resources 98
4.3.2 Least Cost Dispatch for Generators with Constant Variable
Cost 99
4.3.3 Example 101
4.4 Optimal Dispatch of Both Generation and Load Assets 102
4.5 Symmetry in the Treatment of Generation and Load 104
4.5.1 Symmetry Between Buyer-Owned Generators and Stand-Alone
Generators 104
4.5.2 Symmetry Between Total Surplus Maximisation and Generation
Cost Minimisation 105
4.6 The Benefit Function 105
4.7 Nonconvexities in Production: Minimum Operating Levels
106
4.8 Efficient Dispatch of Energy-Limited Resources 108
4.8.1 Example 109
4.9 Efficient Dispatch in the Presence of Ramp-Rate Constraints
110
4.9.1 Example 111
4.10 Startup Costs and the Unit-Commitment Decision 113
4.11 Summary 115
Questions 116
Further Reading 117
5 Achieving Efficient Use of Generation and Load Resources
using a Market Mechanism in an Industry with no Network Constraints
119
5.1 Decentralisation, Competition and Market Mechanisms 119
5.2 Achieving Optimal Dispatch Through Competitive Bidding
121
5.3 Variation in Wholesale Market Design 123
5.3.1 Compulsory Gross Pool or Net Pool? 124
5.3.2 Single Price or Pay-as-Bid? 125
5.4 Day-Ahead Versus Real-Time Markets 126
5.4.1 Improving the Quality of Short-Term Price Forecasts
127
5.4.2 Reducing the Exercise of Market Power 129
5.5 Price Controls and Rationing 129
5.5.1 Inadequate Metering and Involuntary Load Shedding 131
5.6 Time-Varying Demand, the Load-Duration Curve and the
Price-Duration Curve 133
5.7 Summary 135
Questions 137
Further Reading 137
6 Representing Network Constraints 139
6.1 Representing Networks Mathematically 139
6.2 Net Injections, Power Flows and the DC Load Flow Model
141
6.2.1 The DC Load Flow Model 144
6.3 The Matrix of Power Transfer Distribution Factors 145
6.3.1 Converting between Reference Nodes 146
6.4 Distribution Factors for Radial Networks 146
6.5 Constraint Equations and the Set of Feasible Injections
147
6.6 Summary 151
Questions 152
7 Efficient Dispatch of Generation and Consumption Resources
in the Presence of Network Congestion 153
7.1 Optimal Dispatch with Network Constraints 153
7.1.1 Achieving Optimal Dispatch Using a Smart Market 155
7.2 Optimal Dispatch in a Radial Network 156
7.3 Optimal Dispatch in a Two-Node Network 157
7.4 Optimal Dispatch in a Three-Node Meshed Network 159
7.5 Optimal Dispatch in a Four-Node Network 161
7.6 Properties of Nodal Prices with a Single Binding Constraint
162
7.7 How Many Independent Nodal Prices Exist? 163
7.8 The Merchandising Surplus, Settlement Residues and the
Congestion Rents 163
7.8.1 Merchandising Surplus and Congestion Rents 163
7.8.2 Settlement Residues 164
7.8.3 Merchandising Surplus in a Three-Node Network 165
7.9 Network Losses 166
7.9.1 Losses, Settlement Residues and Merchandising Surplus
167
7.9.2 Losses and Optimal Dispatch 168
7.10 Summary 169
Questions 170
Further Reading 170
8 Efficient Network Operation 171
8.1 Efficient Operation of DC Interconnectors 171
8.1.1 Entrepreneurial DC Network Operation 173
8.2 Optimal Network Switching 173
8.2.1 Network Switching and Network Contingencies 174
8.2.2 A Worked Example 174
8.2.3 Entrepreneurial Network Switching? 176
8.3 Summary 177
Questions 178
Further Reading 178
PART IV EFFICIENT INVESTMENT IN GENERATION AND CONSUMPTION
ASSETS 179
9 Efficient Investment in Generation and Consumption Assets
181
9.1 The Optimal Generation Investment Problem 181
9.2 The Optimal Level of Generation Capacity with Downward
Sloping Demand 183
9.2.1 The Case of Inelastic Demand 185
9.3 The Optimal Mix of Generation Capacity with Downward Sloping
Demand 186
9.4 The Optimal Mix of Generation with Inelastic Demand 189
9.5 Screening Curve Analysis 191
9.5.1 Using Screening Curves to Assess the Impact of Increased
Renewable Penetration 192
9.5.2 Generation Investment in the Presence of Network
Constraints 193
9.6 Buyer-Side Investment 193
9.7 Summary 195
Questions 196
Further Reading 197
10 Market-Based Investment in Electricity Generation
199
10.1 Decentralised Generation Investment Decisions 199
10.2 Can We Trust Competitive Markets to Deliver an Efficient
Level of Investment in Generation? 201
10.2.1 Episodes of High Prices as an Essential Part of an
Energy-Only Market 201
10.2.2 The ?Missing Money? Problem 202
10.2.3 Energy-Only Markets and the Investment Boom?Bust
Cycle 203
10.3 Price Caps, Reserve Margins and Capacity Payments 203
10.3.1 Reserve Requirements 204
10.3.2 Capacity Markets 205
10.4 Time-Averaging of Network Charges and Generation Investment
206
10.5 Summary 207
Questions 207
PART V HANDLING CONTINGENCIES: EFFICIENT DISPATCH IN THE VERY
SHORT RUN 209
11 Efficient Operation of the Power System in the Very
Short-Run 211
11.1 Introduction to Contingencies 211
11.2 Efficient Handling of Contingencies 212
11.3 Preventive and Corrective Actions 213
11.4 Satisfactory and Secure Operating States 215
11.5 Optimal Dispatch in the Very Short Run 216
11.6 Operating the Power System Ex Ante as though Certain
Contingencies have Already Happened 218
11.7 Examples of Optimal Short-Run Dispatch 219
11.7.1 A Second Example, Ignoring Network Constraints 221
11.7.2 A Further Example with Network Constraints 222
11.8 Optimal Short-Run Dispatch Using a Competitive Market
223
11.8.1 A Simple Example 224
11.8.2 Optimal Short-Run Dispatch through Prices 227
11.8.3 Investment Incentives 228
11.9 Summary 229
Questions 230
Further Reading 230
12 Frequency-Based Dispatch of Balancing Services 231
12.1 The Intradispatch Interval Dispatch Mechanism 231
12.2 Frequency-Based Dispatch of Balancing Services 232
12.3 Implications of Ignoring Network Constraints when Handling
Contingencies 233
12.3.1 The Feasible Set of Injections with a Frequency-Based
IDIDM 235
12.4 Procurement of Frequency-Based Balancing Services 238
12.4.1 The Volume of Frequency Control Balancing Services
Required 238
12.4.2 Procurement of Balancing Services 239
12.4.3 Allocating the Costs of Balancing Services 240
12.5 Summary 241
Questions 242
Further Reading 242
PART VI MANAGING RISK 243
13 Managing Intertemporal Price Risks 245
13.1 Introduction to Forward Markets and Standard Hedge
Contracts 245
13.1.1 Instruments for Managing Risk: Swaps, Caps, Collars and
Floors 246
13.1.2 Swaps 246
13.1.3 Caps 247
13.1.4 Floors 248
13.1.5 Collars (and Related Instruments) 249
13.2 The Construction of a Perfect Hedge: The Theory 249
13.2.1 The Design of a Perfect Hedge 250
13.3 The Construction of a Perfect Hedge: Specific Cases 252
13.3.1 Hedging by a Generator with no Cost Uncertainty 252
13.3.2 Hedging Cost-Shifting Risks 254
13.4 Hedging by Customers 256
13.4.1 Hedging by a Customer with a Constant Utility Function
257
13.4.2 Hedging Utility-Shifting Risks 258
13.5 The Role of the Trader 259
13.5.1 Risks Facing Individual Traders 261
13.6 Intertemporal Hedging and Generation Investment 263
13.7 Summary 264
Questions 265
14 Managing Interlocational Price Risk 267
14.1 The Role of the Merchandising Surplus in Facilitating
Interlocational Hedging 267
14.1.1 Packaging the Merchandising Surplus in a Way that
Facilitates Hedging 269
14.2 Interlocational Transmission Rights: CapFTRs 269
14.3 Interlocational Transmission Rights: Fixed-Volume FTRs
271
14.3.1 Revenue Adequacy 271
14.3.2 Are Fixed-Volume FTRs a Useful Hedging Instrument?
273
14.4 Interlocational Hedging and Transmission Investment 273
14.4.1 Infinitesimal Investment in Network Capacity 274
14.4.2 Lumpy Investment in Network Capacity 274
14.5 Summary 276
Questions 277
Further Reading 277
PART VII MARKET POWER 279
15 Market Power in Electricity Markets 281
15.1 An Introduction to Market Power in Electricity Markets
281
15.1.1 Definition of Market Power 281
15.1.2 Market Power in Electricity Markets 282
15.2 How Do Generators Exercise Market Power? Theory 284
15.2.1 The Price?Volume Trade-Off 284
15.2.2 The Profit-Maximising Choice of Rate of Production for a
Generator with Market Power 286
15.2.3 The Profit-Maximising Offer Curve 287
15.3 How do Generators Exercise Market Power? Practice 289
15.3.1 Economic and Physical Withholding 289
15.3.2 Pricing Up and the Marginal Generator 291
15.4 The Incentive to Exercise Market Power: The Importance of
the Residual Demand Curve 292
15.4.1 The Shape of the Residual Demand Curve 293
15.4.2 The Importance of Peak Versus Off-Peak for the Exercise
of Market Power 293
15.4.3 Other Influences on the Shape of the Residual Demand
Curve 295
15.5 The Incentive to Exercise Market Power: The Impact of the
Hedge Position of a Generator 295
15.5.1 Short-Term Versus Long-Term Hedge Products and the
Exercise of Market Power 297
15.5.2 Hedge Contracts and Market Power 297
15.6 The Exercise of Market Power by Loads and Vertical
Integration 298
15.6.1 Vertical Integration 299
15.7 Is the Exercise of Market Power Necessary to Stimulate
Generation Investment? 300
15.8 The Consequences of the Exercise of Market Power 301
15.8.1 Short-Run Efficiency Impacts of Market Power 301
15.8.2 Longer-Run Efficiency Impacts of Market Power 302
15.8.3 A Worked Example 302
15.9 Summary 304
Questions 306
Further Reading 306
16 Market Power and Network Congestion 307
16.1 The Exercise of Market Power by a Single Generator in a
Radial Network 307
16.1.1 The Exercise of Market Power by a Single Generator in a
Radial Network: The Theory 308
16.2 The Exercise of Market Power by a Single Generator in a
Meshed Network 311
16.3 The Exercise of Market Power by a Portfolio of Generators
313
16.4 The Effect of Transmission Rights on Market Power 314
16.5 Summary 315
Questions 315
Further Reading 315
17 Detecting, Modelling and Mitigating Market Power
317
17.1 Approaches to Assessing Market Power 317
17.2 Detecting the Exercise of Market Power Through the
Examination of Market Outcomes in the Past 318
17.2.1 Quantity-Withdrawal Studies 319
17.2.2 Price?Cost Margin Studies 321
17.3 Simple Indicators of Market Power 322
17.3.1 Market-Share-Based Measures and the HHI 322
17.3.2 The PSI and RSI Indicators 324
17.3.3 Variants of the PSI and RSI Indicators 326
17.3.4 Measuring the Elasticity of Residual Demand 328
17.4 Modelling of Market Power 330
17.4.1 Modelling of Market Power in Practice 331
17.4.2 Linearisation 332
17.5 Policies to Reduce Market Power 332
17.6 Summary 333
Questions 334
Further Reading 334
PART VIII NETWORK REGULATION AND INVESTMENT 335
18 Efficient Investment in Network Assets 337
18.1 Efficient AC Network Investment 337
18.2 Financial Implications of Network Investment 338
18.2.1 The Two-Node Graphical Representation 339
18.2.2 Financial Indicators of the Benefit of Network Expansion
341
18.3 Efficient Investment in a Radial Network 342
18.4 Efficient Investment in a Two-Node Network 344
18.4.1 Example 345
18.5 Coordination of Generation and Network Investment in
Practice 348
18.6 Summary 350
Questions 351
Further Reading 351
PART IX CONTEMPORARY ISSUES 353
19 Regional Pricing and Its Problems 355
19.1 An Introduction to Regional Pricing 355
19.2 Regional Pricing Without Constrained-on and Constrained-off
Payments 357
19.2.1 Short-Run Effects of Regional Pricing in a Simple Network
360
19.2.2 Effects of Regional Pricing on the Balance Sheet of the
System Operator 361
19.2.3 Long-Run Effects of Regional Pricing on Investment
363
19.3 Regional Pricing with Constrained-on and Constrained-off
Payments 364
19.4 Nodal Pricing for Generators/Regional Pricing for Consumers
367
19.4.1 Side Deals and Net Metering 367
19.5 Summary 369
Questions 370
Further Reading 370
20 The Smart Grid and Efficient Pricing of Distribution
Networks 371
20.1 Efficient Pricing of Distribution Networks 371
20.1.1 The Smart Grid and Distribution Pricing 373
20.2 Decentralisation of the Dispatch Task 374
20.2.1 Decentralisation in Theory 374
20.3 Retail Tariff Structures and the Incentive to Misrepresent
Local Production and Consumption 377
20.3.1 Incentives for Net Metering and the Effective Price
378
20.4 Incentives for Investment in Controllable Embedded
Generation 380
20.4.1 Incentives for Investment in Intermittent Solar PV
Embedded Generation 384
20.4.2 Retail Tariff Structures and the Death Spiral 385
20.4.3 An Illustration of the Death Spiral 386
20.5 Retail Tariff Structures 388
20.5.1 Retail Tariff Debates 389
20.6 Declining Demand for Network Services and Increasing
Returns to Scale 390
20.7 Summary 393
Questions 395
References 397
Index 399
