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Energy and Reserve Market Designs With Explicit Consideration to Lost Opportunity Costs
Deqiang Gan and Eugene Litvinov
AbstractThe primary goal of this work is to investigate the basic energy and reserve dispatch optimization (cooptimization) in the setting of a pool-based market. Of particular interest is the modeling of lost opportunity cost introduced by reserve allocation. We derive the marginal costs of energy and reserves under a variety of market designs. We also analyze existence, algorithm, and multiplicity of optimal solutions. The results of this study are used to support the reserve market design and implementation in ISO New England control area. Index TermsElectricity market, marginal pricing, optimization, power systems, spinning reserve.

While the idea of locational marginal pricing advocated in [5][7] seemingly dominates the pool-based energy markets, there is little consensus on how to structure reserve markets. In fact, the design of reserve markets is often a debatable topic. Discussions on this topic can be found in, say, [8][12], [22]. One of the current major tasks in the ISO New England, Inc. is to study and possibly improve the existing reserve market. Aside from a long-term forward market, which will not be discussed here, the following four alternative designs received attention in this effort: generators receive availability paymentsmodel (A); generators receive lost opportunity cost paymentsmodel (L); generators receive availability and lost opportunity cost paymentsmodel (A L); generators receive either availability or lost opportunity cost paymentmodel (A L). Availability payment refers to the payment to generators that offer reserve capability to the market. The definition of lost opportunity cost incurred in reserve allocation can be found in the next section. More details about it can be found in New York, PJM, or the New England ISO website. The existing ISO-NE market, which is undertaking a major revision, follows model (A L). The revised market design will likely follow a variant of model (A L) as outlined in [23]. We will briefly discuss this revised market design subsequently. The three electricity markets in the Northeastern U.S. all have or will have energy and reserve markets where lost opportunity costs are explicitly compensated. Whether or not generator lost opportunity cost should be compensated is a policy issue. If under certain market design generators do receive lost opportunity cost compensation, then energy, reserve, and lost opportunity cost are cooptimized. This is at present a common practice. A systematic treatment on the formulation, solution algorithm, and pricing analysis of cooptimization becomes a timely issue. The primary goal of this work is to study the basic principles of cooptimization, laying down the engineering foundations of energy/reserve market design. The results can also be valuable for market implementation. We do not investigate how to choose the optimal market design which would require substantial economic analysis [13][15], [24]. Of particular interest in this work is to present a general approach for modeling lost opportunity cost. In the context of cooptimization, we derive the formulae for calculating marginal costs under a variety of market designs. We also investigate such issues as solution existence, algorithm, and multiplicity of cooptimization.

NOMENCLATURE Node energy demand, a vector. System reserve demand (or requirement), a scalar. Unit vector, every elements of is unity. Lost opportunity cost function. Transmission thermal limit vector. Index set of generators (consists of 1, 2, 3, ). Lost opportunity cost price. Energy bid price/generation. Reserve bid price/allocation. Generation sensitivity factor matrix. Equals to 1 or 0 indicating if a generator incurs lost opportunity cost. Energy nodal price vector. Reserve clearing price. I. INTRODUCTION HERE EXIST two school of thoughts for market design as deregulation in power industry proceeds. They are commonly known as pool model and bilateral model [1], [2]. ISO New England (ISO-NE) control area electricity market follows the concept of pool model [3] and [4]. In a pool-based market, energy and reserves are centrally and optimally allocated based on volunteer bids (in this paper reserve refers to 10-min spinning reserve). Under two-settlement design [4], the allocation of energy and reserves is implemented in two stepsday-ahead scheduling and real-time dispatch. The optimization concepts of the two steps are, broadly speaking, similar. In this study, we focus on the market design issues in the real-time dispatch setting.
Manuscript received January 23, 2002; revised June 21, 2002. D. Gan was with ISO New England, Inc., Holyoke, MA 01040 USA. He is now at Zhejiang University, Zhejiang 310027, China (e-mail: dgan@zju.edu.cn). E. Litvinov is with ISO New England, Inc., Holyoke, MA 01040 USA (e-mail: elitvinov@iso-ne.com). Digital Object Identifier 10.1109/TPWRS.2002.807052

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is as follows. As in an existing ISO-NE market, the lost opportunity cost function is defined as (4) where is the final energy price which is not known until the problem is solved. In other words, the optimization problem is self-referential. A number of engineering questions arise during discussions on reserve market design at ISO-NE. Is there a rigorous formulation for the above nondifferentiable, and possibly self-referential, optimization problem? Does an optimal solution exist? Is the optimal solution unique? Is there an efficient solution algorithm? In subsequent sections, we will try to investigate into these engineering problems, the answer of which can be, apparently, of importance in market design and implementation. We look into these problems for each market design model described in the introductory section. Whether or not a particular market design is superior, from market design perspective, than others is not the primary concern of this work. III. LOST OPPORTUNITY COST FUNCTIONS Suppose in a pool-based power market each generator submits a single bid block. The energy-only dispatch for one dispatch interval (5 min in the ISO-NE) can be expressed as [4][6] (5-1) (5-2) (5-3) (5-4) In the line flow model (5-3), for brevity, we assume that power flows in one direction only, and the same linear constraint can be used to enforce line flow limits in the opposite direction. The dispatch solution of the above model, let it be , does not need to respect reserve requirement. Some generators may have to be backed down to provide reserve. The lost opportunity cost of a generator can be defined as follows: (6) . is controversial. We conThe choice of specific form of sider two alternative cases: is a constant vector obtained from energy-only dispatch optimization (5-1)(5-4); is the final energy price which itself is a variable of the optimization. For ease of exposition, the multiblock bids are not considered in this paper, the results could be easily extended to a multiblock case. IV. FORMULATION WHEN CONSTANT PRICE IS USED CALCULATING LOST OPPORTUNITY COST
IN

Fig. 1.

Lost opportunity cost of generator A.

II. PROBLEM Let us start with a simple example. The energy-only dispatch problem in a two-generator market (generator and ) is as follows: (1-1) (1-2) and are energy dispatch; the coefficients (10 and where 20) in the objective function are the bid prices of energy. The optimal solution is as follows: energy clearing price Now suppose reserve requirement is 20, and one would like to dispatch energy and reserve so as to minimize energy and reserve production cost. The dispatch problem becomes (2-1) (2-2) (2-3) (2-4) where the coefficients in the objective function (0 and 15) are the reserve bids. The solution of the problem is easily found as

If the above dispatch solution is implemented, generator would incur a lost opportunity cost which is equal to (see Fig. 1). For various reasons, generators may be entitled to receive availability payment as well as lost opportunity cost payment. . So the total production cost would become To find out the least-cost dispatch, one has to simultaneously optimize the production cost of energy, reserve, and lost opportunity cost. We have the following optimization formulation: (3-1) (3-2) (3-3) (3-4) (3-5) The above problem has a nondifferentiable objective function which requires customized treatment. A more difficult problem

In this section, the lost opportunity cost function is assumed to take the following form: (7) where is the constant energy price vector obtained from energy-only dispatch optimization (5).

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A. Optimization Formulation and Solution Existence Let us define a constant vector as follows: (8) we have (9) The graph of a lost opportunity cost function is illustrated in Fig. 2. Obviously, it is nondifferentiable but it is continuous. The problem of energy and reserve dispatch with consideration of lost opportunity cost is as follows: (10-1) (10-2) (10-3) (10-4) (10-5) (10-6) (10-7) The above model corresponds to market design model (A L). To obtain the optimization model for market design in the above model (A), one only needs to assume that model. To obtain the optimization model for market design, in the above model. model (L), one needs to assume that In the recent proposal [23], generators that are able to provide reserves are classified as tier 1 and tier 2 resources. In a nutshell, tier 1 resources do not incur lost opportunity cost while tier 2 resources do. The optimization formulation for tier 1 resource is simply an energy-only optimization, and the optimization formulation for tier 2 resources is similar to that of model (A L). By the continuity of objective function of the above problem, the answer to the question of solution existence is a qualified yes, provided the feasible set of the problem is nonempty [16, Weierstrass Theorem]. Now let us briefly discuss the optimization formulation for model (A L). It can be stated as follows: (11-1) (11-2) (11-3) (11-4) (11-5) (11-6) (11-7) The 01 variables are introduced to enforce the condition that a generator either receives reserve availability payment or lost opportunity cost payment. Mathematically, this model is similar to model (A L), so we will not discuss it further. But the results to be presented can be extended to deal with this model. Before proceeding to study the solution algorithm, we note that locational reserve requirements are not discussed here (12) With the above manipulations, the energy and reserve dispatch problem can be reformulated as a 01 mixed integer programming problem as (13-1) (13-2) (13-3) (13-4) (13-5) (13-6) (13-7) (13-8) The above 01 problem can be solved using the standard branch- and-bound method [19]. Note that the integer variables are associated with generators with reserve capabilities only. In ISO-NE, the number of generators is approximately 350, but the number of generators that have reserve capability is only about 50. Whether or not the standard branch-and-bound algorithm can meet the requirement of real-time application is out of the scope of this study. However, the formulation (13) allows us to investigate the pricing issues of energy and reserves. C. Optimality Conditions and Marginal Costs Suppose we find the optimal integer solution . Now it is straightforward to derive the marginal costs of energy and reserve. As usual, let , , , and be Lagrangian multipliers
Fig. 2. Lost opportunity cost function when a constant price is used.

but theoretically they could be incorporated into the presented framework without conceptual difficulty using methods presented in the literature [17], [18]. B. Solution Algorithm This section suggests a solution algorithm for the optimization problem (10). First, let us convert the nondifferentiable lost opportunity cost function into a discrete function as follows:

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of constraints in equations (15)(17), we form the Lagrangian function as follows:

multiple solutions in reserve allocation. In fact, there is a continuum of reserve solutions. For instance, consider the following problem: (17-1) (17-2) (17-3) (17-4)

(14) If the th generator has lost opportunity cost, then we have that , . By the standard KuhnTucker optimality , and conditions, we have that (15-1) (15-2) The nodal energy prices are given by the marginal cost vector [5], [6]. The reserve price is also set to the marginal cost . If the th generator does not have lost opportunity cost, we , . By the standard KuhnTucker have . It follows that: optimality theory, (16-1) (16-2) . The energy price is again the marginal cost The reserve price is still given by . In the next section, we will present a pricing analysis based on equations (15) and (16). V. PRICING ANALYSIS FOR ALTERNATIVE MARKET DESIGNS In this section, we present a pricing analysis for each of the models mentioned in the previous section. Whenever possible, we will indicate if multiple solutions exist. A. Model (A) . The reserve clearing price Under this simple model, equals to the reserve availability price of the most expensive generator that is designated to supply reserve. The past experience gained in ISO-NE is that bid prices for reserves are often zero because for many generators reserve costs are sunk costs and they are ensured lost opportunity costs. Under model (A), it is less likely that generators will ask for zero reserve prices because they do not receive lost opportunity cost. However, there is no guarantee that most generators will ask for reserve prices that are greater than zero. When the bid prices for reserves of many generators are equal to zero (under uniform price auction many generators do bid and, generally, there are zero prices), then it is likely that

, , but any The optimal energy dispatch is is an optimal reserve reserve dispatch that meets dispatch. To find an unique solution, one method is to designate reserve contributions to the generators with lowest energy bid prices. A major concern about this model is that when cheaper and fast-start generators are backed down to provide reserve, they have a disincentive to follow ISO dispatch instructions. B. Model (L) . Let us consider two situations. In the Under this model, first situation, the optimal dispatch does not require paying generators lost opportunity cost. This is just the situation in model (A) when the bid prices for reserves are all equal to zero. So it is quite possible that there are multiple solutions for reserve allocation. To resolve this problem, again, one could designate reserve contributions to generators with lowest energy bid prices. Now let us consider the second situation where, in the optimal dispatch, some generators are paid lost opportunity cost. In the sequel, we show that the marginal cost of producing reserves, , can still be greater than zero. To get a feel of what could be, let us derive an alternative expression of from equations (15-1)(15-2) (18) When there is no congestion, it is obvious that , . Since (19) Recall that the marginal cost of a product is equal to the change of production cost as the demand increases by a small amount [20]. Based on this principle, let us verify the result (19) by looking at an example noncongested five-generator system as illustrated in Figs. 3 and 4. Suppose reserve requirement is increased by a infinitesimal . Suppose generator is the only one that is capable of supplying reserve, the change of total production cost would consist of three components ; energy cost increase of generator , which is ; energy cost decrease of generator , which is lost opportunity cost increase of generator , which is . happens to be equal to the clearing price. The Note that change of production cost would be . This indicates that the reserve marginal cost is equal to which is consistent with the result in (19) if one considers and in this example. that

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Fig. 3.

Clearing energy-only market in a five-generator system.

When there is no congestion, the solution of the above problem coincides with the solution of the problem where lost opportunity cost is explicitly included in objective function. This can be illustrated using Fig. 4 in which generator or can provide reserve (assume that they are the only generators that can provide reserves) but they also demand lost opportunity cost. Based on formulation (20), generator would be designated to provide reserve and it would be paid lost opportunity cost. Apparently, if lost opportunity cost is included explicitly into (20-1), the optimal solution would still be the same. As in the model (L), there are multiple solutions for reserve allocation when there is ample reserve capacity margin. VI. EXAMPLES First let us consider how to solve the two-generator cooptimization problem described in Section II. This example is restated below for convenience

Fig. 4. Clearing energy and reserve market in a five-generator system (the shaded area is designated for reserve).

C. Model (A L) This model, which is being used in the existing ISO-NE market, is quite similar to model (L) except that the problem of solution multiplicity in allocating reserves does not happen very often. The reason is that ISO has availability bids. Following the observation derived from equations (18) and (19), if generator is designated to supply reserve and it has lost opportunity cost, we have (20) D. Model (A L) The pricing analysis for this model is similar to that of model (A L) so we will not proceed further. Under such a model, there can still exist multiple solutions in reserve allocation, but this does not happen very often because ISO has availability bids. E. A Variant of Model (L) This model is the same as model (L) except that lost opportunity cost is not explicitly included in the objective function (but generators do receive lost opportunity cost payment). The optimization formulation is as follows: (20-1) (20-2) (20-3) (20-4) (20-5) (20-6)

First, notice that , , and . The next step is to convert the above nondifferentiable optimization problem into mixed integer programming problem based on equation (10) as follows:

To solve the above mixed integer programming problem, one only needs to solve two linear programs derived by assuming and , respectively. The optimal solution is , , , and . Now we briefly describe an example of an IEEE 118-bus system. There is a congestion across line 8992. We assume that only the two generators at bus 100 and bus 112 have reserve capability. The parameters of these two generators and the energy-only optimization results are illustrated in Table I. The reserve requirement is set to be 200 MW. Under market model (A L), the cooptimization result is that generator at bus 100 is designated to supply reserve, the dispatch of generator at bus 112 is 350 MW (which is the same as its energy-only dispatch). Under market model (A), the result is the opposite. Generator at bus 112 is designated to supply reserve, its generation dispatch is backed off to 150 MW. The above solutions are hardly surprising because under model (A L), generator at bus 112 is more expensive due to lost opportunity cost payment.

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TABLE I PARAMETERS OF TWO GENERATORS OF 118-BUS TEST SYSTEM

In what follows we describe briefly how to solve the bilevel optimization problem (23). By the standard theory of linear programming, the primal and dual solutions of the lower-level subproblem depend on the optimal basis of the lower-level subproblem, that is (24-1) (24-2) is the right-hand-side of the lower-level subwhere problem, it is a linear function of . To attack the bilevel optimization problem, observe that and do not depend on the specific value of , rather they depend on which constraints are included in optimal basis only. As a result, suppose temporarily that the optimal basis is known, then energy prices are known. Let it be and be as defined based on (8). Now the bilevel optimization problem can be cast as (25-1) (25-2) (25-3)

VII. FORMULATION WHEN VARIABLE PRICE IS USED IN CALCULATING LOST OPPORTUNITY COST In this section, we assume that lost opportunity cost function takes the most general form (6). This optimization is self-referential because the lost opportunity cost depends on variable price which is not known until the final solution is obtained. In this section, we suggest a method to get around this impasse. Let us suppose temporarily that the reserve dispatch is given, let it be . Then, it is trivial to compute optimal energy dispatch and resultant energy prices (21-1) (21-2) (21-3) (21-4) The Lagrangian function of the above optimization problem is easily obtained as

(25-4) The above problem possesses a structure that is similar to that of (10). It can be solved using the general algorithm described in Section IV-B. The question remains to be how to find out the optimal basis. One obvious solution is to enumerate all of the combinations of bases of the lower-level subproblem. For example, in the five-generator system illustrated in Fig. 3, where each generator is required to submit a single block bid, there are only five possible energy prices. A better solution is to apply a standard branch-and-bound algorithm [19]. Since a branch-and-bound algorithm is fairly familiar to the power engineering audience, we will not discuss it here. The readers are referred to [19] for details. VIII. FINAL REMARKS In this paper, we studied four alternative energy/reserve market designs that received attention in ISO-NE. We presented a fairly detailed analysis on the basic formulation, solution algorithm, and pricing formulae of cooptimization under these market designs. The results of the research have been used to support, from engineering perspective, the reserve market design and implementation in ISO-NE. Many of the questions raised during discussions on reserve market design at ISO-NE are answered. The main finding is that energy, reserve, and lost opportunity cost cooptimization are, in general, a nondifferentiable and possibly bilevel optimization problem. This problem can be further converted into a mixed integer programming problem. A standard algorithm for solving these problems is that of branch and bound. This algorithm can be efficient or exceedingly slow, depending upon the size of the problem. Whether or not a standard branch-and-bound algorithm can meet engineering requirements is thus a subject of additional research.

(22) . The key to The spot prices are given by solving the problem is to find out an energy dispatch that is optimized taking into account reserve requirements. Consider the following bilevel optimization problem: (23-1) (23-2)

(23-3) (23-4) (23-5) (23-6) (23-7) (23-8) In the above formulation, is a variable in the upper-level optimization and a parameter in the lower-level optimization. stays in the lower-level optimization subproblem. The primal solution of the above bilevel optimization problem is the desired optimal dispatch of energy and reserves. The dual solution contains locational marginal prices.

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ACKNOWLEDGMENT The authors have benefitted from the discussions in ISO-NE Reserve Market Design Working Group. The opinions described in the paper do not necessarily reflect those of ISO New England, Inc. The authors remain solely responsible for errors. REFERENCES
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[15] R. Zimmerman, R. Thomas, D. Gan, and C. Murillo-Sanchez, A webbased platform for experimental investigation of electric power auctions, Decision Support Syst., vol. 24, no. 3&4, pp. 193205, Jan. 1999. [16] M. S. Bazaraa, H. D. Sherali, and C. M. Shetty, Nonlinear ProgrammingTheory and Algorithms, 2nd ed. New York: Wiley, 1993. [17] S. Hao and D. Shirmohammadi, Clearing prices computation for integrated generation, reserve and transmission markets, in Proc. PICA, Sydney, Australia, May 2001. [18] M. Aganagic, K. H. Abdul-Rahman, and J. G. Waight, Spot pricing of capacities for generation and transmission of reserve in an extended poolco model, IEEE Trans. Power Syst., vol. 13, pp. 11281134, Aug. 1998. [19] J. F. Bard, Practical Bilevel OptimizationAlgorithms and Applications. Norwell, MA: Kluwer, 1998. [20] P. R. Gribik, G. A. Angelidis, and R. R. Kovas, Transmission access and pricing with multiple separate energy forward markets, IEEE Trans. Power Syst., vol. 14, pp. 865876, Aug. 1999. [21] A. Jayantilal, K. W. Cheung, P. Shamsollahi, and F. S. Bresler, Market based regulation for the PJM electricity market, in Proc. PICA, Sydney, Australia, May 2001. [22] N. S. Rau, Optimal dispatch of a system based on offers and bidsA mixed integer LP formulation, IEEE Trans. Power Syst., vol. 14, pp. 274279, Feb. 1999. [23] PJM Interconnection, L.L.C. (2001, July) Spinning Reserve Market Business Rules. [Online]. Available: http://www.pjm.com. [24] K. Seeley, J. Lawarree, and C.-C. Liu, Analysis of electricity market rules and their effects on strategic behavior in a noncongestive grid, IEEE Trans. Power Syst., vol. 15, pp. 157162, Feb. 2000.

Deqiang Gan received the Ph.D.degree in electrical engineering from Xian Jiaotong University, Xian, China, in 1994. Currently, he is with Zhejiang University, Zhejiang, China. He was a Senior Analyst in ISO New England, Inc., Holyoke, MA, where he worked on issues related to the design, implementation, and economic analysis of electricity markets. Prior to joining ISO New England, Inc., he held research positions at several universities in the U.S. and Japan.

Eugene Litvinov obtained the B.S. and M.S. degrees from the Technical University, Kiev, Ukraine, U.S.S.R., and the Ph.D. degree from Urals Polytechnic Institute, Sverdlovsk, Russia. Currently, he is a Director of Technology with the ISO New England, Holyoke, MA. His main interests are power system market clearing models, system security, computer applications to power systems, and information technology.