Rethinking the Price Formation Problem-Part 2: Rewarding Flexibility and Managing Price Risk

Brent Eldridge, Bernard Knueven, Jacob Mays

Research output: Contribution to journalArticlepeer-review


Part 1 of this two-part paper describes the impact that uncertainty has on the design and analysis of price formation policies in the non-convex auctions conducted by U.S. wholesale electricity market operators. Using first a toy model and then a large-scale test system, Part 2 demonstrates the difference in prices under the idealized benchmark of ex ante convex hull pricing defined in Part 1 versus existing methods, in particular documenting the potential for suppression of volatility and therefore under-compensation of flexibility by existing methods. The examples highlight that inefficient spot price formation can induce inefficient forward commitments of generators, necessitating out-of-market intervention to restore a reliable and efficient operating plan.Given the potential side effects of existing policies for investment and operation, we suggest two elements in a reoriented approach to the price formation problem: first ensuring that prices exhibit full-strength volatility, and second ensuring that risk-averse market participants have sufficient ability to manage this volatility.
Original languageAmerican English
Pages (from-to)490-498
Number of pages9
JournalIEEE Transactions on Energy Markets, Policy and Regulation
Issue number4
StatePublished - 2023

NREL Publication Number

  • NREL/JA-2C00-85874


  • electricity market design
  • price formation
  • risk trading
  • virtual bidding


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