How it works
The grid operator solves one optimisation for the whole network. It finds the cheapest set of generator outputs that meets demand at every node without overloading any line. The LMP at a node is the change in total system cost if demand there rose by one MWh. Where no line is at its limit, LMPs across the system differ only by losses. Where a line is full, the next MWh behind it must come from a dearer local plant, and the LMP there rises.
Each LMP is published in $/MWh as three components. The energy component is the same across the system. The congestion component reflects lines at their limits, and the loss component reflects energy lost on the wires. Prices are set for thousands of nodes, by the hour in the day-ahead market and every five minutes in real time. Generators are paid the LMP at their own node, while load usually pays a zonal average. Trading hubs average many nodes into one price that contracts can reference.
Why it matters
A project is paid at its own node, which may sit well below the hub price that a PPA or a forecast quotes. That gap, called basis, can remove much of a wind or solar project's margin where many plants share a congested area. Developers study historical nodal prices before choosing a site. IPPs need nodal price forecasts to bid, and hedges against basis, such as financial transmission rights, to protect revenue.
A worked example
A wind farm sells under a virtual PPA settled at the hub, and receives its own nodal price for the power. In one hour the hub LMP is $40/MWh. At the farm's node the energy component is $38, congestion −$15 and losses −$1, so the LMP is 38 − 15 − 1 = $22/MWh. The PPA pays the strike against the hub, so the farm absorbs the $18/MWh gap. On 100 MWh, that is 100 × $18 = $1,800.
Illustrative figures.
Across markets
LMP is used across the organised US markets, including PJM, MISO, ERCOT, CAISO and New York. Europe prices by bidding zone, usually a whole country, and resolves congestion inside a zone by redispatch paid for by the grid operator. India uses one national price that splits into regional bid areas only when inter-regional links are congested. Nodal pricing has been debated in parts of Europe without being adopted.