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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

March 20, 2000. A2.

Smith, Vernon L., "Experimental Studies of Discrimination Versus Competition in Sealed-Bid Auction Markets." , 40:1, 56-84, January 1967.

U.S. Department of Energy, "Horizontal Market Power in Restructured Electricity Markets." DOE/PO-0060, Office of Policy, USDOE, March 2000.

Wilson, R., "Auctions of Shares." , Vol. 93, 675-689, 1979.

Wolak, Frank A., Severin Borenstein, James Bushnell, "Diagnosing Market Power in California's Restructured Wholesale Electricity Market." Stanford University, www.stanford.edu/~wolak/, April 2000.

Wolfram, Catherine D., "Strategic bidding in a multiunit auction: an empirical analysis of bids to supply electricity in England and Wales." , Vol. 29, No. 4. Winter 1998.

1 In his seminal work on market auctions, Smith (1967) proposed that in shallow market conditions, bid values and related revenues would be higher in "last bid sets price" price auctions than in "pay as bid" auctions. Subsequent research appears to confirm Smith's findings (Wilson 1979, Back and Zender, 1993, Wolfram 1998). Wolfram (1998) suggests that the incentives for high-priced, strategic bids "would not exist if the electricity auction were discriminatory." DOE (2000) states that a recent analysis by Wolak (2000) indicates that exercise of market power in California during the summers of 1998 and 1999 resulted in more than $800 million in payments above competitive levels to generators. More recently, the "last bid sets price" method has garnered the attention of the broader media as a cause of high electricity prices in the Northeast (Smith 2000).

2 The Federal Energy Regulatory Commission has defined ancillary services as those "necessary to support the transmission of electric power from seller to purchaser given the obligations of control areas and transmitting utilities within those control areas to maintain reliable operations of the interconnected transmission system." Ancillary services include regulation (maintaining minute-to-minute generation/load balancing), spinning reserve (capacity that is synchronized to the grid that can respond immediately to grid disturbances), and non-spinning reserve (capacity not connected to the system but capable of being brought on-line and serving demand quickly, e.g., 10 minutes).

3 Under uniform price auctions, bidders are not compelled to bid the expected marginal cost, as only one plant will determine the payment value for all successful bidders. As a result, zero price bids have been observed in uniform price auctions in order to guarantee selection. In a discriminatory price auction, each bidder must submit a more carefully considered bid, as the revenue obtained will be directly related to the bid amount.

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