EBF 483
Introduction to Electricity Markets

8.6 The Two Settlement Payment System

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Remember that the "energy market" run by the RTO consists of two stages: the day-ahead market and the real-time market. The RTO will accept offers from generators and will calculate LMPs in each of the two markets. The day-ahead LMPs represent prices arising from a dispatch based on a 24 hour ahead demand forecast. The real-time LMPs represent prices arising from the dispatch based on a one-hour ahead demand forecast.

You may be wondering why the day-ahead market is needed at all. Remember that supply and demand of electricity must match in real-time, and not all generators have the flexibility (ramp rate) to be able to respond instantaneously. Some level of centralized coordination is probably necessary. The day-ahead market determines which plants are scheduled to run the next day. It does not determine which plants will actually run the next day - that happens based on real-time calculations, although it is often the case that if a power plant is committed to run in the day-ahead market then it will actually be dispatched in real time.

The purpose of the real-time market is to allow the RTO to make adjustments to the economic dispatch based on changes in its demand forecast between the 24 hour ahead time frame and the 1 hour ahead time frame (usually the hour-ahead forecast is going to be more accurate). Generators participating in the real time market will submit what amount to adjustment offers. A generator that cleared the day-ahead market to produce a given amount could then submit a supplementary offer in the real-time market.

It is thus possible that a generator could "clear" a certain quantity in the day-ahead market and "clear" a different quantity in the real-time market. The total payments to generators for both day-ahead and real-time markets will depend upon the prevailing LMPs in the day-ahead and real-time markets. This payment process is called the "two settlement system" and it is used not only in PJM but in other RTOs as well.

Here we'll describe the basics of the two-settlement system and use it to determine generator payments. Suppose that a generator clears an amount GDA in the day-ahead market and an amount GRT in the real-time market. The total payments to that generator under the two settlement system would be:

Payment = Q DA LMP DA  + ( Q RT  - Q DA ) LMP RT

As a simple example, a generator who cleared 10 MWh in the day-ahead market and 11 MWh in the real-time market with prices LMPDA = $5/MWh and LMPDA = $10/MWh would get a total payment under the two settlement system of $60 (being made up of $50 in day ahead and $10 in real time).

But what if a generator is cleared to produce electricity in the day-ahead market but isn't needed when the RTO clears the real-time market based on its hour-ahead demand forecast? That generator would probably have incurred some costs to be "committed," or ready to generate electricity on a 24-hour ahead basis. In these cases, the RTO will typically reimburse the generator for any costs directly connected to being committed to produce electricity (which, remember is different than actually producing electricity). These payments are variously called "uplift" or "out of market" payments, and are not reflected in any LMP.

Finally, we'll illustrate the two settlement system on our three node network, which is illustrated in Figure 7.7 in Section 4. The day-ahead demand forecast at Node C is 10 MWh. The marginal cost of generator A is MC( G A )  = 6 + 2 G A and the marginal cost of generator B is MC( G B )  = 2 + G B . The economic dispatch is G A = 2 MWh ; G B = 8 MWh , and the flows on the three transmission lines are F AB = -2 MW , F AC = 4 MW and F BC = 6 MW . The System Marginal Price in this case would be $10/MWh, which is the marginal cost of either generator at the economic dispatch point (use the marginal cost functions to verify this). Because there is no transmission congestion, the LMP is equal to $10/MWh at all locations.

We will set the same flow limits on the transmission lines as before:

  • Flow on A-B  10 MW
  • Flow on A-C  10 MW
  • Flow on B-C  6 MW

Suppose that demand at Node C increases to 11 MWh in real time. As with our previous three node example, the RTO adjusts the dispatch so that GA = 4 MWh, GB = 7 MWh. The LMPs become:

LMP( A ) = MC( G A ) = 6 + 2 × 4 =  $14/ MWh

LMP( B ) = MC( G B ) = 2 + 7 =  $9/ MWh

LMP( C ) = 2 × MC( G A = 4 ) + ( -1 ) × MC( G B  = 7 )

                = 2 × $14 - 1 × $9 = $19/ MWh

(If you don't remember why, see Section 5 or try to figure it out for yourself!)

Under the two settlement system we would have the following payments to generators:

Generator A: 2 MWh ×  $10/ MWh  + ( 4-2 ) MWh ×  $14/ MWh  = $48

Generator B: 8 MWh ×  $10/ MWh  + ( 7-8 ) MWh ×  $9/ MWh  = $71

Note that the adjustment term for Generator B in the two settlement equation is negative (7 MWh - 8 MWh). This simply reflects that Generator B produces less energy than was originally cleared in the day-ahead market.