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Pay-as-Bid vs. Uniform Pricing

Discriminatory auctions promote strategic bidding and market manipulation.

Fortnightly Magazine - March 2008

model produce lower electricity costs for consumers?

Although pay-as-bid auctions may appear like a quick fix for rising prices, switching to a pay-as-bid approach likely would produce just the opposite result. This counter-intuitive outcome stems from the propensity for strategic-bidding behavior, as well as the resulting inefficiencies in plant dispatch and capacity investment. A change in auction design would do little to other pressing market concerns, including ensuring adequate T&D resources and increasing the role of demand response. Further, continued changing of market rules creates regulatory uncertainty and fears of regulator opportunism that may discourage investment in new generation and transmission facilities.

Economic Efficiency

Based on long-standing principles, even when it was composed of highly regulated utilities providing power under a government-authorized monopoly structure, the electric industry’s clear goal has been to provide reliable power as efficiently as possible. 5 In theory, efficiently produced and supplied power supports the goal of providing electricity to consumers at the lowest price.

But what does “efficiency” mean for electricity markets? First, it’s important to distinguish between short-run (static) efficiency and long-run (dynamic) efficiency. Static efficiency means: 1) output is produced by the least-cost suppliers; 2) it is consumed by those most willing to pay for it, and; 3) the right amount is produced. Achieving short-run productive efficiency (for a given load) essentially has devolved into the problem of operating existing power resources ( i.e., existing plants and dispatchable demand-side resources 6) according to the principle of economic dispatch—that is, running plants in a dispatch order so the ones with lowest operating costs, or short-run marginal costs, are dispatched ahead of others with higher operating costs.

The nature of the electricity grid—including transmission constraints and reliability requirements, and resource constraints, such as plant start-up costs or ramping times, and demand-response notice periods for different facilities—adds many wrinkles to achieving least-cost dispatch, but doesn’t fundamentally change the problem. Solving this problem effectively depends on information that allows control operators to order plants and other resources from least-costly to most-costly—and a host of other things, such as the degree control operators can minimize system costs over a wide geographic grid, issues that are not greatly affected by choice of auction design.

Even as some parts of the country have shifted control of the grid from regulated utilities to RTOs, the basic process by which least-cost dispatch is implemented has not changed dramatically. In all regions, control-area operators minimize system costs given the security constraints of maintaining system reliability—that is, satisfying all demand for power. An important difference emerges, however, in the information used by control-area operators to minimize costs. While non-RTO regions rely upon cost data provided by the utilities, RTO regions rely on auction-based bids from suppliers. While there are many important differences between RTO and non-RTO models affecting economic dispatch— e.g., the effectiveness of resource “pooling” across states and utility service areas and access to transmission rights—an important issue differentiating alternative auction designs is their ability to elicit accurate information about the relative costs of operating power plants.

While economic dispatch is designed