European Journal of Operational Research Pricing of Fluctuations in Electricity Markets

In an electric power system, demand fluctuations may result in significant ancillary cost to suppliers. Furthermore, in the near future, deep penetration of volatile renewable electricity generation is expected to exacerbate the variability of demand on conventional thermal generating units. We address this issue by explicitly modeling the ancillary cost associated with demand variability. We note that a time-varying price equal to the suppliers' instantaneous marginal cost may not achieve social optimality, and that consumer demand fluctuations should be properly priced. We propose a dynamic pricing mechanism that explicitly encourages consumers to adapt their consumption so as to offset the variability of demand on conventional units. Through a dynamic game-theoretic formulation, we show that (under suitable convexity assumptions) the proposed pricing mechanism achieves social optimality asymptotically, as the number of consumers increases to infinity.