Energy prices in the presence of plant indivisibilities

In several countries (Chile, Bolivia, Argentina and Peru, among others), power plants are dispatched according to merit order, i.e., based on the marginal operating costs of the plants. In this scheme, the plant with the highest marginal cost sets the spot price at which firms trade the energy requires to fulfill their contracts. The model assumes that plants can operate at any level up to capacity, whereas real power plants have minimum operating levels. This implies that a low cost plant might have to reduce its supply in order to accommodate the minimum operating level of a more expensive power plant. This paper derives the welfare maximizing price rules in this case and shows that the standard peak load pricing rules no longer apply.