Author: Wick Eisenberg
A night-time view of multiple illuminated electricity pylons and power lines against a dusk sky.
“Ironically, increasing prices to ration scarce capacity can lower average prices over the long-term by avoiding building unneeded extra capacity and by motivating consumers who can voluntarily reduce or shift the timing of their demands to do so.” — Benjamin F. Hobbs, Theodore M. and Kay W. Schad Professor of Environmental Management

Research from the Ralph O’Connor Sustainable Energy Institute (ROSEI) reveals how various pricing strategies in U.S. electricity markets affect the cost of electricity. The study, “Reserve and energy scarcity pricing in United States power markets: A comparative review of principles and practices,” is published in Renewable and Sustainable Energy Reviews, highlights the importance of improving the current pricing of both energy and the reserve capacity needed to back up generation if surprises happen during scarcity conditions.  Improved pricing can ensure a reliable energy grid; the authors offer recommendations for improving electricity market efficiency.   

“There isn’t an industry-recognized best way to approach scarcity, so independent system operators have different methods for adjusting techniques and changing values,” said Mahdi Mehrtash, an assistant research professor who worked with Benjamin F. Hobbs in the Department of Environmental Health and Engineering on the analysis. “We analyzed what different ISOs (independent system operators) are doing, and which practices are more or less effective for the grid system as a whole.” 

Errors in forecasting demand and electricity availability for a power grid mean that ISOs must have sufficient reserves to keep the real-time operation of the system reliable. But when there isn’t enough electricity in reserve, operators often set higher prices for reserves and energy to motivate available suppliers to produce more and to inform consumers to help avoid similar conditions in the future by decreasing their usage or shifting it to other times, if possible. This procedure, which is called scarcity or shortage pricing, is a core feature of US electricity markets. 

The Hopkins team’s analysis offers three primary recommendations for ISOs trying to improve the electricity market efficiency.  

  • Make penalties for reserve shortages—situations when ISOs don’t keep adequate extra generating capacity available—higher when shortages are more severe. 
  • Don’t dictate in advance when scarcity prices should be used; instead, take real-time context like weather and time of day into account. 
  • Keep the amount of electricity in reserve as consistent as possible so it’ll be easier to predict when scarcity prices will be needed.  

The researchers said that their takeaways focus on maximizing efficiency for the grid as a whole rather than trying to ensure consumers pay less for their electricity bills.  

“Though improving efficiency in managing scarcity might not seem important now, it will become crucial to achieving the goal of decarbonizing the power sector,” Mehrtash said. “As we grow to rely more on solar and wind, which are less predictable, improving and optimizing efficiency will ensure a reliable energy grid.”  

According to Hobbs, well-managed scarcity is a necessary part of the electricity energy market. 

“Take a parking lot, for example. If it’s never full of cars, it was probably built too big to begin with. Essentially, our analysis shows that there should be shortages some of the time, or else you’ve created an unnecessary number of resources for energy for the grid, and scarcity helps balance that,” he said.  

However, fear of elevated electricity prices is standing in the way of the team’s measures being implemented, Hobbs said. 

“The reason our takeaways aren’t common practice currently is because price caps were implemented to protect consumers after instances when energy providers considerably raised prices to create artificial scarcity when it wasn’t necessary,” he said. “Price caps protect consumers but also dilute incentives to conserve electricity. If a consumer doesn’t need their air conditioning, it’s best that they turn it off so power can be saved for essentials like hospitals or grocery stores. With price caps, you’re less likely to have people making that choice because using electricity won’t hurt them as much financially.” 

“Ironically,” Hobbs continued. “Increasing prices to ration scarce capacity can lower average prices over the long-term by avoiding building unneeded extra capacity and by motivating consumers who can voluntarily reduce or shift the timing of their demands to do so.” 

Since their analysis was published, Hobbs and Mehrtash have received positive feedback from various ISOs and the California ISO (CAISO) has asked to see their simulation results—a sign that their research is starting to connect with those in industry, they say. 

“The goal with this kind of paper is that it makes others aware of the analysis and that there are better ways to implement scarcity in electricity markets than what is currently happening,” Mehrtash said. “I hope that we’ll see some of this implemented in the next few years. It takes time, changing policies isn’t easy and a lot of it depends on policymakers, and how fast they want to change or adapt.” 

The research was funded by the US Department of Energy through the Grid Management Laboratory Consortium headed by Argonne National Lab.