What Is Locational Marginal Pricing?
Locational marginal pricing (LMP) is a market-pricing approach used to manage the efficient use of the transmission system when congestion occurs on the bulk power grid.
Congestion arises when one or more restrictions on the transmission system prevent the economic, or least expensive, supply of energy from serving the demand. For example, transmission lines may not have enough capacity to carry all the electricity to meet the demand in a certain location. This is called a "transmission constraint." LMP includes the cost of supplying the more expensive electricity in those locations, thus providing a precise, market-based method for pricing energy that includes the "cost of congestion."
LMP provides market participants a clear and accurate signal of the price of electricity at every location on the grid. These prices, in turn, reveal the value of locating new generation, upgrading transmission, or reducing electricity consumption—elements needed in a well-functioning market to alleviate constraints, increase competition and improve the system’s ability to meet power demand.
Unlike the original market in New England, in which there is only one energy clearing price, under SMD, prices are calculated at three types of locations: the node, the load zone and the hub. Offers and bids are submitted, markets settle, and LMPs are calculated at these locations.