Electricity Markets (cont)
In addition, the laws of physics determine how electricity flows through an electricity network. Hence the extent of electricity lost in transmission and the level of congestion on any particular branch of the network will influence the economic dispatch of the generation units.
The theoretical price of electricity at each node on the network is a calculated "shadow price", in which it is assumed that one additional kilowatt-hour is demanded at the node in question, and the hypothetical incremental cost to the system that would result from the optimized redispatch of available units establishes the hypothetical production cost of the hypothetical kilowatt-hour. This is known as locational marginal pricing (LMP) or nodal pricing and is used in some deregulated markets, most notably in the PJM, New York and New England markets in the USA and in New Zealand. However, many established markets do not employ nodal pricing, examples being the UK, Powernext and Nord Pool (Scandinavia and Finland). While in theory the LMP concepts are useful and not evidently subject to manipulation, in practice system operators have substantial discretion over LMP results through the ability to classify units as running in "out-of-merit dispatch", which are thereby excluded from the LMP calculation. In most systems, units that are dispatched to provide reactive power to support transmission grids are declared to be "out-of-merit" (even though these are typically the same units that are located in constrained areas and would otherwise result in scarcity signals). System operators also normally bring units online to hold as "spinning-reserve" to protect against sudden outages or unexpectedly rapid ramps in demand, and declare them "out-of-merit". The result is often a substantial reduction in clearing price at a time when increasing demand would otherwise result in escalating prices.
