Operators of organized wholesale electricity markets attempt to form prices in such a way that the private incentives of market participants are consistent with a socially optimal commitment and dispatch schedule. In the U.S. context, several competing price formation schemes have been proposed to address the non-convex production cost functions characteristic of most generation technologies. This paper considers how the design and analysis of price formation policies for non-convex markets is affected by the uncertainty inherent in electricity demand and supply. We argue that by excluding uncertainty, the analytical framework underlying existing policies mischaracterizes the incentives of market participants, leading to inefficient price formation and poor incentives for flexibility. We establish favorable theoretical properties of a new construct, ex ante convex hull pricing, demonstrate the difference between this policy and existing methods on an ISO-scale test system, and discuss the implications for price formation in organized wholesale markets.
Working Paper, School of Civil and Environmental Engineering, Cornell University