1

Decision Making under Uncertainty in

Electricity Markets
L. A. Barroso, Member, IEEE, and A. J. Conejo, Fellow, IEEE

incorporated into operational decisions [13]. Wallace and

Abstract — This paper considers stochastic programming
models for decision-making under uncertainty in the context of
electricity markets. It provides a brief overview of modeling and
solution techniques within a mathematical programming
framework. Tutorial as well as recent references are provided.
This paper provides the guidelines for discussion in a panel
session organized by the authors on “Decision Making under
Uncertainty in Electricity Markets”, scheduled for the IEEE PES
2006 General Meeting.
Fleten provide a good survey on stochastic programming
models in energy [14].
This paper is organized as follows. Section II identifies
uncertainty sources, Section III describes the elements to be
considered to make decisions under uncertainty, Section IV
provides a description of the mathematical framework to make
optimal decisions. Section V addresses computational issues
and and Section VI provides conclusions.

Index Terms — Electricity markets, uncertainty, operations II. UNCERTAINTY SOURCES

planning, decision making.
As widely discussed in the literature, within an electricity
I. INTRODUCTION market the main sources of uncertainty include:
1. Prices of energy, reserves and regulation.
T his paper considers stochastic programming models for
decision making under uncertainty in the context of
electricity markets. It focuses on operational decisions, i.e.
2. Fuel prices.
3. Fuel availability (for example, uncertainty in gas
supply and uncertainty in hydro inflows to reservoir for
decisions that do not imply building new equipment. hydroelectric production).
It identifies the main sources of uncertainty in electricity 4. Energy demand.
markets, describes the basics of decision making under 5. Regulatory issues: uncertainty in orders and laws.
uncertainty, reviews mathematical models to address these Whereas uncertainty sources 1-4 are mathematical tractable,
decision making process, and provides introductory references 5 is not. This paper thus focuses on uncertainties of type 1-4
on stochastic programming. for decision making within an electricity market framework.
An essential observation is that neither a good nor a feasible
solution is attained solving a problem in which random III. DECISION MAKING UNDER UNCERTAINTY
variables are substituted by their respective expected values.
For decision making under uncertainty, the first issue to
The solution attained solving this deterministic problem is
address is the decision time framework, which divide
generally infeasible for random variable realizations different
decisions among those (here-and-now) to be taken before
than the expected values of these variables. Furthermore, that
future information materializes and those (wait-and-see) that
solution lacks versatility as it is only adapted to the expected
can be deferred to once future information materializes.
values of the random variables and not to other equally
Then, it is crucial to establish the objective to be pursued.
probable realizations.
Two objectives are usually considered: maximizing expected
Basic background on stochastic programming and decision
profit (or expected linear utility) with disregard of profit
making under uncertainty can be found in the tutorial paper by
volatility, which corresponds to a risk-neutral approach, and
Sen and Higle [1] and in the ubiquitous and excellent textbook
maximizing expected profit limiting the volatility (risk) of that
by Birge and Louveaux [2]. Other relevant books include
profit, which incorporates the risk profile (usually aversion) of
Higle and Sen [3], Kall and Mayer [4] and the publicly
players. The risk profile can be incorporated in several
available book by Kall and Wallace [5]. Recent references on
different ways, including risk constraints, VaR constraints,
stochastic programming applied to decision making in
utility functions, among others.
electricity market include [6]-[13], which propose different
One possible and convenient manner of describing the
approaches to generate bidding strategies for electricity spot
realization of the random variables (or processes) involved is
markets under uncertainty, considering stochastic values for
a scenario tree, i.e., a discrete but comprehensive description
bidding behavior, spot prices and inflows on the multi-stage
of the realizations of the random variables with their
scheduling of hydro systems. Risk management has also been
associated probabilities.
A set of important constraints restricting the decision
L.A.Barroso is with Power Systems Research, Rio de Janeiro, Brazil making are those that explicitly specify that decision have to
(email: luiz@psr-inc.com). be taken using the information available up to the decision
A. J. Conejo is with Univ. Castilla – La Mancha, Ciudad Real, Spain time but not information only available after that time. These
(email: Antonio.Conejo@uclm.es).

1-4244-0493-2/06/$20.00 ©2006 IEEE.


fundamental constraints are denominated nonanticipativity
constraints.
Finally, it is important to characterize the decision
attained using appropriate quality metrics, being particularity
relevant the VSS (Value of the Stochastic Solution) index that
measures the advantage obtained as a result of properly
modeling the uncertainty involved.
IV. STOCHASTIC PROGRAMMING APPROACH
Stochastic programming (where “programming” means
“planning”) is mathematical programming under uncertainty,
that is, any mathematical program where one or more of the
coefficients are not fully known at the time of decision
making. The randomness may stem from the uncertainties
described in Section II, such as unknown prices, uncertain
demand, varying quality of raw materials or random behavior
of operators, to mention but a few examples. So, stochastic
programming is a problem class.
Three mathematical modeling approaches are generally
considered to solve stochastic programs, namely, (i)
mathematical programs with recourse, (ii) deterministic
programs that incorporate penalties to diminish infeasibilities
and (iii) programs with probabilistic constraints. Among those
approaches, the first one is the more versatile and widely used.
Mathematical programs with recourse allow determining
here-and-now first stage decisions and policies for wait-and-
see second (and subsequent) stage decisions. That is, wait-
and-see decisions allow improving here-and-now decisions
once scenarios materialize. In other words, while deterministic
multiperiod optimization yields decisions for all periods, a
stochastic approach only yields policies or strategies. The
well-known Stochastic Dynamic Programming (SDP)
technique has been widely applied as a flexible solution
procedure in the context of stochastic recourse problems.
The deterministic programs with penalties to diminish
infeasibilities use the expected values of the random variables
to formulate a deterministic problem that incorporates
penalties in the objective function to minimize infeasibilities
due to scenario realizations different from expected values.
Programs with probability constraints include constraints
that should be satisfied with a certain probability value, not
always.
V. COMPUTATIONAL ISSUES
The greatest challenge of stochastic programming is indeed
the increase of the computational effort and scale of problems
with the number of scenarios, with the number of probabilistic
constraints, number of stages, etc. In this context, the use of
stochastic programming techniques has been recently (late 80s
and 90s) mixed with decomposition approaches in a step
forward to overcome the “curse of dimensionality” of
stochastic problems. For example, among these techniques,
we can mention the Stochastic Dual Dynamic Programming
(SDDP) [15] – a technique that makes a “bridge” between
SDP and multi-stage Benders Decomposition – and hybrid
SDP/SDDP schemes [16] to accommodate stochastic
2
functions with saddle points. These schemes have been
applied to the scheduling of large-scale hydropower systems
in competitive framework in more than thirty countries,
including detailed modeling of stochastic system components
(inflows and prices) and transmission networks [17,18].
On the other hand, if the stochastic programming problem
is formulated as a mixed-integer linear programming problem,
scenario reduction techniques [19] might allow reducing
drastically the number of scenarios considered without
reducing significantly the stochastic information embedded in
the scenario tree. If this is the case, the resulting reduced
problem can be directly attacked using state-of-the-art mixed-
integer linear programming solvers, such as GAMS-CPLEX
[20].
VI. CONCLUSIONS
This paper provides an introduction to the use of stochastic
programming techniques for decision making under
uncertainty in electricity markets. Uncertainty sources are
identified, main ingredients of the decision making process are
reviewed, and the features of the mathematical approaches to
achieve optimal decisions are described. Tutorial as well as
recent relevant references are provided.
This work serves as the basis for discussion in a panel
session on “Decision Making under Uncertainty in Electricity
Markets”, organized by the authors and held at the IEEE PES
2006 General Meeting. The main objective of this panel
session is to discuss recent modeling issues and the supporting
mathematical methodologies that would be useful to deal with
uncertainty in decision making. Presentations will address
more specific models and their applications as well as a
description of the numerical procedures and strategies that
have been developed for certain classes of stochastic
programming problems. The panel will be centered on energy
problems where the uncertainty is of a technological nature; in
particular as it comes up in the production of energy, risk
management, power system planning and dynamic decision
making in electricity markets.
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 3

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BIOGRAPHIES
Luiz Augusto Barroso has a BSc in Mathematics and a MSc and PhD in
optimization from UFRJ. He joined PSR in 1999, where he has been working
and researching on power systems economics, planning and operation,
focusing on hydrothermal systems. He has been a speaker on those subjects in
Latin America, Europe and US/Canada.

Antonio J. Conejo (F'04) received the M.S. degree from MIT, Cambridge,
MA, in 1987, and a Ph.D. degree from the Royal Institute of Technology,
Stockholm, Sweden in 1990. He is currently a full Professor at the
Universidad de Castilla-La Mancha, Ciudad Real, Spain. His research interests
include control, operations, planning and economics of electric energy
systems, as well as statistics and optimization theory and its applications.