Bid Cost Minimization versus Payment Cost Minimization in the ISO/RTO Markets

Summary form only given. In deregulated electricity markets, an auction mechanism is used to select supply bids for energy and ancillary services. Currently, most independent system operators in the US use an auction mechanism that minimizes total supply bid costs. This "bid cost minimization" auction causes an inconsistency between the minimized bid costs and the consumer payments that are calculated based on market clearing prices (MCPs). This gives rise to "payment cost minimization," an alternative auction mechanism that directly minimizes consumer payments. This presentation summarizes mathematical formulations for the bid cost and payment cost minimizations for simultaneous optimal auctions in the ISO/RTO markets and the newly developed solution methodology using augmented Lagrangrian relaxation and surrogate optimization to solve the payment cost minimization. The testing result demonstrates significant potential savings for electricity consumers if the payment cost minimization is implemented in the ISO/RTO markets. Importantly, the presentation will address economic implications of the objective function choice, including whether maximizing social welfare should be one of objectives of electricity industry deregulation. We conclude that such an objective which is to maximize social welfare, even if it were determined to be desirable, is not achievable based on current bidding rules after moving from traditional vertical integrated utilities into a market approach, and is certainly not achieved through the bid cost minimization approach in use today. Other implications of bid cost minimization, such as the inconsistency between the actual payment and cost function minimized and impacts on bidding behaviors, are also discussed. Furthermore, we analyze the potential bidding behavior differences between the two minimization approaches and we believe that investigating market behaviors is necessary to comprehensively assess the auction mechanisms. Strategic beha- - vior of market participants are studied within the Nash equilibrium framework for the two auction mechanisms. A simple two- supplier example is first analytically studied to provide insights. Games with more realistic settings are then solved as matrix games using our previously developed auction algorithms. Results demonstrate cost savings for consumers under payment cost minimization as compared to bid cost minimization. Production efficiency and solution properties are also examined for the two auction mechanisms.