What objective function should be used for optimal auctions in the ISO/RTO electricity market?

Abstract

In this paper, we provide mathematical formulations for the offer cost and MCP payment cost minimizations for optimal auctions in the ISO/RTO electricity market, and summarize the newly developed solution methodology using augmented Lagrangian relaxation and surrogate optimization for solving the optimal auction with the MCP payment objective function. Data has been used to test the method based on a simplified energy market, and for a given set of offers, the testing result demonstrates significant potential savings for electricity consumers if the MCP payment cost minimization is implemented in the ISO/RTO electricity markets. More importantly, this paper addresses economic implications of the objective function choice, including whether maximizing social welfare should be one of objectives of electricity industry deregulation. We conclude that an objective to maximize social welfare, even if it were determined to be desirable, is not achievable based on current bidding rules after moving from traditional vertically integrated utilities to a market approach, and is certainly not achieved by the offer cost minimization approach in use today. Other implications such as the inconsistency between the actual payment and the cost function minimized, and bidding behaviors are also discussed