Strategic Behavior in Day-Ahead and Real-Time Markets for Electricity: Offer Cost or Payment Cost Minimization?

This study compares the procurement cost-minimizing and productive efficiency performance of the auction mechanism used by independent system operators (ISOs) in wholesale electricity auction markets in the U.S. with that of a proposed alternative. The current practice allocates energy contracts as if the auction featured a discriminatory final payment method when, in fact, the markets are uniform price auctions. The proposed alternative explicitly accounts for the market clearing price during the allocation phase. We find that the proposed alternative largely outperforms the current practice on the basis of procurement costs in the context of simple auction markets featuring both day-ahead and real-time auctions and that the procurement cost advantage of the alternative is complete when we simulate the effects of increased competition. We also find that a trade-off between the objectives of procurement cost minimization and productive efficiency emerges in our simple auction markets and persists in the face of increased competition.

Efficiency in Deregulated Electricity Markets: Offer Cost Minimization vs. Payment Cost Minimization Auction

This study of the wholesale electricity market compares the efficiency performance of the auction mechanism currently in place in U.S. markets with the performance of a proposed mechanism. The analysis highlights the importance of considering strategic behavior when comparing different institutional systems. We find that in concentrated markets, neither auction mechanism can guarantee an efficient allocation. The advantage of the current mechanism increases with increased price competition if market demand is perfectly inelastic. However, if market demand has some responsiveness to price, the superiority of the current auction with respect to efficiency is not that obvious. We present a case where the proposed auction outperforms the current mechanism on efficiency even if all offers reflect true production costs. We also find that a market designer might face a choice problem with a tradeoff between lower electricity cost and production efficiency. Some implications for social welfare are discussed as well.

Can a Newly Proposed Mechanism for Allocating Contracts in U.S. Electricity Wholesale Markets Lead to Lower Prices? A Game Theoretic Analysis

This study of the wholesale electricity market compares the cost-minimizing performance of the auction mechanism currently in place in U.S. markets with the performance of a proposed replacement. The current mechanism chooses an allocation of contracts that minimizes a fictional cost calculated using pay-as-offer pricing. Then suppliers are paid the market clearing price. The proposed mechanism uses the market clearing price in the allocation phase as well as in the payment phase. In concentrated markets, the proposed mechanism outperforms the current mechanism even when strategic behavior by suppliers is taken into account. The advantage of the proposed mechanism increases with increased price competition.