Incentives for efficient use of storage in electric power systems

Michael Giberson

In the most recent Energy Journal, Ramteem Sioshonsi has an article examining the welfare effects of the incentives to use energy storage in electric power systems. (“Welfare Impacts of Electricity Storage and the Implications of Ownership Structure,” See volume 31:2 here.) He considers the incentives faced by consumers, generators, and merchant energy storage owners (companies lacking consumer or generator affiliates).

His theoretical analysis demonstrates:

[W]elfare-maximizing storage use benefits consumers while reducing producer profits, [and therefore] will result in consumers and producers having vastly different incentives to use storage from one another and from merchant storage owners.  This is because the three different agent types will use storage to maximize their net payoffs. In the case of consumers this would consist of the sum of arbitrage value and consumer surplus change, whereas producers would maximize the sum of generation and arbitrage profits.  Merchant storage operators, on the other hand, will maximize arbitrage profits only.  Because consumer surplus is enhanced by welfare-maximizing storage use, and since consumers that own storage would not consider the impact of storage use on generator profits, they will tend to have an incentive to overuse storage.  Conversely, because storage use reduces producer profits, generators will have an incentive to underuse storage.

A numerical analysis based loosely on ERCOT system characteristics in 2005 provides further elaboration of the model.

Our numerical example showed that for most reasonable storage device efficiencies merchant ownership of storage is welfare-maximizing compared to the alternatives of consumer or generator ownership….  When storage assets can be divided amongst agent types the socially optimal allocation of storage favors merchants, although some consumer ownership of storage can be beneficial since their overuse of storage can compensate for underuse by merchants.

Sioshonsi observes that as the number of storage operators increases, overall use of storage capability approaches the social welfare maximizing outcome.  This is, of course, the familiar effect of competition in markets on welfare.

Reading this paper I couldn’t help but think of the Tres Amigas proposal, which I think would be the first merchant energy storage project of any significant size if built. (Am I overlooking any large grid-connected merchant energy storage projects?)  While this article was far from an analysis of the welfare consequences of building the Tres Amigas project, it does suggest that the project’s storage capability would offer substantial public benefits.

Sioshonsi only considers use of energy storage to buy and sell energy, but grid-connected energy storage can also be used to provide transmission support services (generally called “ancillary services”).  When energy storage gets built as a transmission-system component and factored into regulated transmission rates, regulations tend to prevent that energy storage from being used for energy price arbitrage.  So, “transmission-system” energy storage assets will be underused relative to the public interest.  But markets for ancillary services are incomplete, meaning merchant incentives to supply ancillary services may also be underdeveloped.  Most of the regional, integrated power markets (i.e. RTOs) have substantially improved their ancillary services markets over the past several years, and the way forward here is to continue to improve ancillary services markets.

ASIDE: Sioshonsi also notes that an integrated utility with consumer loads and its own generation assets may inherently favor the socially optimum welfare use of storage assets, “since these entities would be concerned with both producer and consumer surplus.”  However, this expansive claim is just an add-on remark in the conclusion not examined in the body of the paper.  Suffice to say that if the interests of integrated utilities were always aligned with both producer and consumer surplus, we could dispense with both restructuring and regulation and let consumers live in the warm embrace of unregulated, integrated monopoly power companies.

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2 thoughts on “Incentives for efficient use of storage in electric power systems

  1. Bruce Radford wrote about three public-welfare cases before FERC, including Tres-Amigas, in his Public Utilities Fortnightly column <a href="http://bit.ly/9q6oty"('Outsmarting the Grid,' Commission Watch, February 2010). He pointed out that Tres Amigas, for all its techie uber-coolness, “could end up as a bridge to nowhere. Its success depends entirely on whether it can convince other parties in ERCOT, SPP, and the Western Interconnection to build transmission lines to the superstation in Clovis, so that Tres Amigas receives injections of power to re-route among the various grids.” http://bit.ly/9q6oty

  2. Thanks Michael, I’ll take a look. Once upon a time interconnections between power systems where driven by integrated utilities seeking to improve transmission system reliability and gain access to economical supplemental energy. These days the world is more complicated. Consumers facing high costs and producers with low costs obviously benefit from expanding connections between regions, but consumers in low cost areas and producers with high costs can lose out. Overall economic welfare increases, but the benefits are widely dispersed, often leaving value-increasing interconnections without much of a coalition of support within RTO stakeholder processes.

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