LMP Components

Electricity does not have one price. It has thousands, changing every five minutes at every point on the grid. A megawatt-hour in downtown Chicago might cost $45 while the same megawatt-hour 200 miles away in rural Illinois costs $25. The difference is not a market inefficiency. It is a locational marginal price (LMP) doing exactly what it is designed to do.

LMP has three components. The energy component reflects the marginal cost of generation to serve the next increment of demand, as if transmission were unlimited. The congestion component captures the cost of transmission constraints: when a cheap generator cannot deliver power because the line is full, a more expensive local generator must run instead. The loss component accounts for energy lost as heat during transmission, which increases with distance.

Decompose a real price. A node in New York City shows an LMP of $65/MWh. Energy component: $30 (the system-wide marginal cost). Congestion: $32 (cheap upstate hydro cannot reach the city because transmission into NYC is constrained). Losses: $3 (transmission losses from upstate).

Who benefits from congestion charges?

Transmission rights holders. If you own a financial transmission right (FTR) on the constrained path, you receive the congestion revenue: the price difference between the cheap source and the expensive sink. FTRs let generators and loads hedge against congestion costs, and their value signals where new transmission would reduce costs most.

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