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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

Each of these services is limited by the user-defined quantity available and unit ramp rate considerations. In a manner similar to the energy assignments, each ancillary demand is matched to generation resources, ranked by bid price.

For each market, the model calculates the amount paid to each unit, the unit's internal variable cost (based on heat rate, fuel cost, and other variable operating costs), and the resulting profit from the transaction. These amounts are summed across all units to obtain a total-market payment, cost, and profit for each service. -R.H.

*Although not universally defined as an ancillary service, load following is included in the model to reflect the capacity margins that must be available for intra-hour load changes.

To quantify the effect of these two pricing approaches, it was assumed for the simulation that market power was exercised in the spinning and non-spinning reserve markets. In these markets, a few bidders (including the marginal bidder) offered reserve at 50 times their plant's normal production cost, resulting in bid prices greater than $1,000 per megawatt-hour. In comparing the impact of the two settlement rules, identical input data (e.g., bids, loads, plant parameters) were used.

For each electricity service (i.e., energy, regulation, spin), the electricity market model determined the degree of utilization, cost, revenue, and profit for each plant submitting a bid. A listing of the outcome for each plant is too lengthy to include in this article, but a summary of the results under both types of price rules appears in the table, "'Last Bid Sets Price' vs. 'Pay as Bid' Pricing." (See p. 48.)

Of particular interest are the results for the spin and non-spin services, where market power has been exercised. Both revenue and related profits received under a "last bid sets price" rule are considerably higher than under the "pay as bid" price rule. These findings are shown in the figure, "Average Electricity Revenue by Auction Rule." A graph of average profits would be nearly identical.

These results reveal that the "last bid sets price" auction rules indeed allow market power in the form of limited competitive bids to influence the entire market. The "pay as bid" price rules, by contrast, limit the impact of such market power by not applying the marginal price to all inframarginal units. Further, by requiring the submission of individual "to be paid" bids, this auction permits greater scrutiny of bidding behavior. And by discouraging the use of market power through greater transparency, "pay as bid" auctions also may reduce strategic capacity withholding, thereby enhancing system reliability.


Back, K., J. F. Zender, "Auctions of Divisible Goods: On the Rationale for the Treasury Experiment." , Vol. 6, 733-764, 1993.

Feldman, Robert A., Rajnish Mehra, "Auctions: A sampling of techniques." , Vol. 30, Issue 3:32, September 1993.

Mount, Timothy, "Market Power and Price Volatility in Restructured Markets for Electricity." , January 5-8, 1999. Maui, Hawaii.

Oren, Shmuel S., "Design of Ancillary Service Markets." Working paper. August 2000. University of California, Berkeley.

Smith, Rebecca, "Northeast Faces Electricity-Price Surge-Costly Oil-Fired Plants May Drive Summer Rates." , Eastern Edition.