Locational marginal pricing, commonly called LMP, is a means of pricing electricity in organized wholesale markets facilitated by Independent System Operators (ISOs). According to the California ISO, LMP is “the marginal cost of supplying, at least cost, the next increment of electric demand at a specific location (node) on the electric power network, taking into account both supply (generation/import) bids and demand (load/export) offers and the physical aspects of the transmission system including transmission and other operational constraints.” LMPs vary hourly depending on the factors described above and can vary widely between different locations. According to economists, they send the right price signal to generators and consumers, telling them exactly when and where power is cheap or expensive.
ISOs commonly set different LMP prices for the same time period including a day-ahead price set the day prior to flow, and fifteen-minute and five-minute real-time prices determined during the operating hour. The locations where prices are set in the electrical system are called nodes. The node that determines what a power plant is paid for providing energy is the generation bus bar, which is the point where the power plant substation connects to the transmission line. Other nodes include the point where two transmission systems connect in a transmission substation and load take-out points where transmission systems connect to distribution systems in a distribution substation. In most ISOs, there are thousands of nodes. ISOs may also calculate indices at virtual market hubs, which are calculated based on a formula using LMPs from specified locations.
Locational prices can vary significantly due to transmission constraints and losses:
Prices at each point on the grid are made up of three components:
- Marginal Energy Component (MEC) — the system clearing price if no congestion exists (this is the same across the system)
- Marginal Loss Cost (MLC) — the cost of marginal losses along transmission paths into a specific node (this varies by location)
- Marginal Congestion Cost (MCC) — the difference between locational costs to serve the marginal megawatt (MW) of load less the system energy price
Thus the formula for determining the LMP at any node is: LMP = MEC + MLC + MCC
Determining LMP is a complex process requiring interaction of various models:
A simplified overview of how LMPs are determined
LMPs determine what energy suppliers are paid for energy at each source of supply and what loads must pay to obtain energy at each load take-out point. LMPs vary across the day based on supply, grid, and load conditions.