We have seen throughout this text that, in principle, the twin goals of efficient use of existing assets and efficient investment in production and consumption assets can be achieved through prices that are differentiated by time and by location known as nodal prices or locational marginal prices. Nodal pricing is used by many electricity markets around the world. However, many markets approximate or vary nodal prices in some way by, for example, failing to differentiate prices adequately by location, or by differentiating prices for producers but not for consumers. In this chapter, we focus on the consequences of failing to differentiate prices adequately by location. Specifically, we will focus on pricing schemes known as regional or zonal pricing.
As we have seen, nodal pricing requires prices that are differentiated by geographic location. Depending on the nature of congestion on the underlying network, nodal pricing may require prices that differ at every node.
Let us consider an alternative approach in which (a) we group nodes into regions, and (b) we set the wholesale price for each node in a region to be the same. This is known as regional or zonal pricing. Figure 19.1 illustrates how different nodes in a network might be grouped into pricing regions. We will be more precise about exactly how the regional price is related (if at all) to the underlying nodal prices shortly.