Economics of Electricity System III: Nonconvexity in power generation and electricity market design

Designing power markets is not easy because power systems have a number of troublesome technical characteristics that can lead to market failure. Perhaps least well known but most intellectually challenging among them are the nonconvexities introduced by generator start-up costs and minimum output constraints. With these nonconvexities a competitive equilibrium may fail to exist, which makes the task of designing electricity markets highly challenging. In Japan as well as other developed countries, the problem of start-up costs is becoming more serious, and the redesign of the electricity market is being considered. This paper reviews two approaches to dealing with nonconvexity in power generation, one European and one U.S. ISO approach. It also discusses the recent developments in pricing under nonconvexity and how to deal with the large forecast errors that have arisen with the rapid increases in variable renewable energy.