Economic theory and the application of incentive contracts to procure operating reserves

The ancillary services market plays an important role in the operation of an electricity market, especially for achieving a high level of reliability. Among all ancillary services, operating reserve is an important research focus, with the attention mainly on the optional procurement and pricing methods. These methods differ in many aspects, including the objective, allocation of risks, and feasibility. In this paper, a new approach is proposed to analyze the users’ reserve procurement problem and a novel reserve trade mechanism is developed between electricity users and the retailer of the market. First, the differences between the procurement of operating reserve in decentralized and centralized ways are analyzed. The comparison of the equilibrium solutions reveals that the centralized procurement that results in a systemic optimal solution is better than the decentralized procurement that results in a Nash equilibrium solution. Furthermore, an incentive contract based on a Principal-agent model, that is able to induce a systemic optimality as well as a Pareto equilibrium and manage risks at the same time is designed. The proposed model is equitable and beneficial to all participants. An example is served to illustrate the features of the model and the methodology.