Analysis of lost opportunity costs for hydropower under the locational marginal pricing mechanism

The development of electricity spot markets is central to China’s power sector reforms, with locational marginal pricing (LMP) serving as the dominant pricing mechanism. Originally designed for thermal-power-dominated systems, LMP faces adaptability challenges as markets become increasingly diversified, particularly with high shares of hydropower. In regions such as Yunnan, the current LMP mechanism has led to lost opportunity costs for hydropower participants, undermining their incentive to follow dispatch instructions. Therefore, this paper focuses on analyzing both the conditions under which LMP ensures hydropower participants’ compliance with dispatch instructions and the root causes of the lost opportunity costs incurred by hydropower in practice. First, this paper establishes a general-form market clearing model incorporating hydropower participants. Based on the definition of LMP, the corresponding electricity price expression for hydropower is derived. Second, considering the operational characteristics of hydropower, an actual self-dispatch model is formulated to quantify lost opportunity costs under LMP. Third, using duality theory and Karush-Kuhn-Tucker optimality conditions, we deduce the conditions under which LMP ensures dispatch-following incentive compatibility and explain the mechanism by which LMP fails, in practice, to guarantee that market participants follow dispatch instructions. Finally, case studies are presented to validate the theoretical findings.