Economic Interpretation of Demand Curves in Multi-product Electricity Markets - Part II: Practice

In the absence of demand-side bids for certain reliability products in the wholesale electricity markets, Independent System Operators (ISOs) traditionally use fixed demand requirements with penalty factors to clear the market. This approach does not allow proper tradeoffs between cost and reliability due to the inelasticity of the fixed requirements. Therefore, ISOs have been replacing the fixed requirements with sloped demand curves. However, the economic interpretation of demand curves, especially for multiple coupled products, is largely missing in both theory and practice. This could lead to the misrepresentation of the demand benefit in the market clearing objective. Using a two-product market model, Part I of this paper reveals two distinct interpretations of demand curves, each associated with a specific form of the market clearing problem. This implies that the construction of demand curves and the use of them in market clearing must be consistent with their economic interpretation. In Part II of this paper, we analyze the sequential and iterative market clearing processes currently implemented in some markets to demonstrate their solution sub-optimality. The root cause of the problem is the lack of a clear representation of the demand benefit. The social surplus optimization based on the proper interpretation of demand curves is proposed.