#1 System Energy Price
LMPs are made up of System Energy Price, Congestion Costs, and Losses. System Energy Price represents the cost to serve power on a system, ignoring transmission and congestion costs.
In organized markets, power plants are dispatched lowest cost to highest cost; hypothetically, if demand was 100 MWs on a system, the System Energy Price would be the cost of turning on the 100th MW of power. System energy prices are the same for all pricing nodes on a system. Price differences in nodes on the same system come from congestion costs and losses. From an LMP pricing perspective, a “system” is an ISO like PJM, MISO, or CAISO.
Source: Energy Acuity LMP Platform
#2 Congestion Cost
Congestion costs represent the price of congestion at binding constraints on the power system. Congestion costs arise when, in order to respect constraints in the transmission system, higher cost generation must be used to meet load as opposed to lower cost generation that would otherwise be used in absence of the constraint.
As a simplified example, let’s say you live in a neighborhood that requires a certain amount of power. There is a low-cost power plant far away that is large enough to power your entire neighborhood; however, there are only enough power lines between the power plant and your neighborhood to supply power for half of the power your neighborhood needs, the rest of the power must be supplied by a higher cost power plant that is closer to the neighborhood.
The difference between the dispatch costs at the lower cost plant and the higher cost plant would be considered the congestion component of LMP in your neighborhood.
#3 Cost of Marginal Losses
The third component of LMPs is the cost of marginal losses. Losses are just electricity that is lost during long-distance transport. So, the closer your power plant is to the load that it is serving, the lower your Losses are, and the further away it is, the higher your Losses are.
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