Sequential Contracts for Uncertain Electricity Resources

The U.S. department of energy recently listed “development of rules for market evolution that enable system flexibility” among the key strategic areas of intervention for a successful integration of renewable energy into the grid [2]. Renewable energy generation from wind and solar is intermittent and its prediction accuracy is precise only within a short time horizon (e.g. 5-15 minutes [1]). Therefore, new market mechanism solutions such as intra-day markets are proposed that allow for flexible generation of renewable energy to exploit the improved forecast accuracy of renewable resources over time [14]. In this paper we study sequential contract design problems that incorporate the arrival of new information about renewable generation and allow for flexible production. Today, the renewable energy generation receives extramarket treatment such as feed-in tariffs, guaranteed grid access, and lenient penalty rate [3, 7]. For example, the Participating Intermittent Resource Program (PIRP) mandates the California independent system operator to accept all the wind generation in real-time and treat them as negative loads. The subsequent increased cost of the required reserve generation capacity is then socialized among the load serving entities (LSE). However, such approaches cannot be sustained for high levels of renewable generation as the imposed reserve generation cost on LSEs becomes excessively high and results in social welfare loss. In the long-run, renewable energy generation needs to participate in electricity markets and be exposed to market mechanisms. An alternative approach, implemented in the U.K., requires the wind generators to bid in conventional electricity markets and pay penalty for ex-post deviation from their ex-ante contracted schedule. Such a firm contracting approach is the subject of many studies in the literature. The works of [4, 15] study the problem of optimal bidding in a two-settlement market structure with an exogenous price and penalty rate. The problem of mechanism design for wind aggregation among many wind producers that jointly participate in a two-settlement market structure with exogenous price and penalty rate is investigated in [8, 10]. The authors in [12] study the problem of auction design for such a two-settlement market structure. In this paper, we propose a simple two-step model to capture the dynamic variable nature of renewable generation and provide a general formulation for flexible forward con-