Part 2: Wholesale Electricity Markets: Is It the LMP, or the LMP Alone?

Part 2 of this blog series argues that focusing on policies that “interfere” with appropriate market signals ignores the limitations of markets for electricity in the first place.

This is part two of a two-part blog series. To read part one, please visit this page.

Concerns over how the price mechanism is determined in wholesale power markets—i.e. prices are set by the marginal cost of the last generator dispatched to meet load at a given location—focus on the possibility of price distortions caused by subsidized renewables. For example, FERC Commissioner Christie argues that we need to reconsider the use of the single clearing price (the LMP), since “public policies have distorted the price mechanism.” Similarly, Commissioner Danly highlights “market-distorting forces (that) originate with subsidies.”

The problem with focusing only on the price distorting impact of subsidized renewables makes it seem that if these subsidies went away, we could get back to allowing prices alone to shape investment decisions in the electricity sector that enable reliable grid operations. This is not accurate.

States that rely on prices alone to incentivize sufficient investment in generation resources embraced economic theories that electricity can be treated as a commodity and that generators are fungible in real-time power operations. In other words, that it doesn’t matter which generator is producing energy, as long as energy is delivered. The reality in wholesale markets for electricity is that generators are not fungible in real-time power system operations, and prices alone have never been enough to ensure sufficient investment in the resources needed to enable the reliable operation of the grid without various fixes

Is this the end of the RTO?

The question of the viability of the RTO model, with a single clearing price based on marginal costs, as more renewables come online, is really a question about the viability of deregulated wholesale power markets to shape investments in the mix of resources needed to meet policy targets and keep the lights on.

RTOs do not set electricity policy; states set electricity policy. RTOs rely on prices to coordinate security-constrained economic dispatch. But whether the prices in RTO wholesale power markets are the only mechanism to coordinate investment decisions in generation resources is a different question from whether the RTO market structure itself is at risk, or is an impediment to reaching clean energy goals.

The issue is not the LMP used in RTO short-term power market operations. The issue is, and has always been, relying on the LMP alone to be the signal for efficient investment in electricity markets.

A reliable grid (the “bulk electric system”) is a public good

Tellingly, a task force set up to consider electricity market competition electricity in the United States reported to Congress nearly twenty years ago that “system reliability, the prevention of network collapse, is a public good.” Preventing network system collapse—a blackout—requires that power system operators have access not just to a sufficient amount of generation resources, but the right technical mix of resources.

Market prices for electricity cannot ensure investment in sufficient generation resources —especially those that meet critical reliability needs during times of system stress. This is the reason why markets for electricity have always required various fixes. (These fixes include capacity markets and/or an operating reserve demand curve price adder.)

Relying on prices alone to ensure the expansion of the transmission system and incentivize the mix of resources needed to enable the reliable operation of the electricity sector—a critical public good—has always been challenging. Focusing only on the price distorting impacts of subsidies for clean energy resources, in markets we already know are limited, distracts from this important point.

Kelli Joseph

Senior Fellow, Kleinman Center
Kelli Joseph is a Kleinman Center Senior Fellow. She works at the intersection of policy and markets, with a focus on transitioning the electricity sector to support a decarbonized, climate resilient economy.