Stochastic modeling of electric power prices in a multi-market environment

Over the past few years, a number of competitive electric power markets have emerged in the United States. While market structure differs by region, the common denominator has been the high level of price volatility experienced in these markets. As power suppliers, marketers and consumers seek to manage their positions in this volatile environment, understanding the locational spreads in power prices is becoming increasingly important. The paper develops a dynamic model describing the interplay of electricity prices in a multi-market environment. In contrast to most existing price models, it is based on the fundamental interaction of demand and supply processes. We illustrate how delays in the information flow to market participants causes price differentials to occur between markets with unconstrained transmission interfaces. Furthermore we examine how correlation between load processes translates into a correlation between the price processes in a dual-market environment. These results are illustrated in a simulated example. In the context of the new model we examine current state of the art algorithms for valuing locational spread options. The work presented suggests that a single correlation factor may not be sufficient to describe the interplay of prices in a dual-market environment. The model illustrates how the price correlation shifts between two states based on the state of congestion on the system. Possibilities for extensions of current option valuation schemes are discussed