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Reforming Bulk Power Auctions: Why Not Pay According to Bid?

Changing settlement rules might offer a fix for broken power markets.
Fortnightly Magazine - October 1 2000

total demand for a given hour will be. Historical data coupled with weather predictions can provide fairly accurate estimates, however. Similarly, bidders cannot predict with certainty the last accepted bid price, so bidders likely would bid their expectation of the marginal price or perhaps slightly less to improve their selection chance. 3

For the given hourly load in this study, the expected marginal price was assumed to be between $200 and $250 per megawatt-hour, with bids varying accordingly. For the few plants whose production cost was greater than $200 per megawatt-hour (e.g., small, oil-fired internal combustion units), the energy bid for that plant was set to its production cost. Ancillary service bids were related to the energy bid, adjusted upward by 5 percent to 15 percent to recognize the incremental cost impacts of varying (and/or lower) output operation.

If that were all that was done to produce plant bids, the economic impact of "last bid sets price" and "pay as bid" price auctions on the consumer would not differ greatly. Thus far, bids have relied on the assumption that the bid price for the marginal unit will be based on its costs with, at most, some allowance for a fair profit. In a competitive market with many potential suppliers, that is not an unreasonable assumption. However, what has been experienced on occasion in actual markets is an exercise of market power in which inadequate supply has caused exorbitant prices to be bid under the logic of charging what the market will or must bear. Whether the shortage is due to true resource shortfalls or intentional supplier withholding, the result is that during that period, suppliers can be the tail that wags the dog. It is in these circumstances that "pay as bid" price rules can protect the consumer by limiting profits that accrue to participating suppliers.

The Electricity Market Simulation Model

In order to understand the economic impacts of alternative market mechanisms in the scheduling and procurement of electric energy, a means of simulating the behavior of markets under various rules and conditions is needed. As part of Oak Ridge National Laboratory's support to the Office of Power Technologies, a multi-generator, multi-hour simulation model has been developed to facilitate analysis of various market arrangements. The ORNL Electricity Market Model (OREMM) serves as a tool to better understand, test, and predict the resulting prices, participation in, profits, and coverage of the interrelated, competitive electric energy and ancillary services markets.

The PC-based simulation model has been designed with the following attributes:

  • Capable of multiple, diverse generation units and fuel types;
  • Sequential hourly analysis of energy and individual ancillary service demands;
  • User-provided bids for energy and ancillary services by unit;
  • Tracking of sales, actual cost, and profit by unit; and
  • Capable of modeling different market rules and behaviors.

The model simulates the auction process in which hourly energy demand is satisfied by bid-ordered generation. After an initial energy assignment has been made, the various ancillary services are considered in order of their required response time (i.e., regulation, then spinning reserve, load following,* and non-spinning reserve).