Locational Marginal Prices

Locational marginal prices (LMPs) are a method used to set the price of electric energy at a specific location and at the time it is delivered. If the lowest-priced electricity can be delivered to all locations, prices are the same across the entire region and generators are selected or dispatched, in order of lowest to highest offer price or cost (merit order) until demand is met. When there is transmission congestion, energy flow to some locations is limited by physical or reliability constraints. In that case, more expensive energy is dispatched (out of merit order) to meet demand at that location. As a result, the LMP is higher in those locations. The methods for calculating LMPs differ among the markets but they are generally based on a security constrained economic dispatch where the economic dispatch is modified from strict merit order to meet operation, transmission, and reliability constraints. Wholesale energy markets for electricity use supplier offers and demand bids in an auction  environment. Traditionally, regulated utilities use cost-based rather than offer-based economic dispatch for the determination of LMPs. Economic theories suggest that in a competitive market, generators will offer at their incremental costs. Market imperfections and complexities, or the exercise of market power, can subvert economic theory in a system as complex as the grid. The LMP can then be defined in terms of the incremental generation price (or production cost) to optimally deliver the next increment of energy-to-load at the specified location, or node, while satisfying all the system operating, transmission, and reliability constraints. Specifically, the LMP is the ratio of the cost increment to the energy increment ($/MWh).

More generally, LMP is a method for managing transmission congestion through pricing in a wholesale market for electricity and was originally proposed by Schweppe et al. (1988) and further developed by Hogan (1992).