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Anatomy of Sealed-Bid Auctions

Bringing flexibility and efficiency to energy RFPs.

Fortnightly Magazine - June 2009

With the introduction of retail competition in the electricity industry, regulatory authorities in many jurisdictions are now overseeing the purchase of electricity at wholesale by electric utilities for customers that do not otherwise obtain supply from independent retailers. There are two primary ways in which, under the supervision of regulatory authorities, electric utilities purchase electricity for these non-shopping customers: through simultaneous descending clock auctions or through fairly common sealed-bid auctions, commonly known as Requests for Proposals (RFPs).

Descending clock auctions have received a lot of coverage in the trade press and academic literature on electricity. In comparison, sealed-bid auctions have not received as much attention. This discrepancy may be explained by the myriad approaches to purchasing wholesale electricity that entail issuing RFPs that tend to obscure the fact that RFPs simply are sealed-bid auctions.

Non-Shopping Customers

In states that have introduced retail competition into the electricity market, end-use customers (such as households and businesses) can purchase their power supplies from retailers that are independent of the local utility company. Many end-use customers, however, do not purchase their power from independent retailers and continue to rely on their local utility company. The regulatory authorities in these states oversee the purchase of electricity by electric utilities to supply such “non-shopping” customers 1 and generally require that the electric utility purchase this power through a competitive process. In most cases, utilities use sealed-bid auctions carried out through RFPs to purchase these power supplies.

Competitive procurements of electricity for such utilities have been reviewed in recent years. 2 The most common competitive procurement process is for the electric utility to solicit sealed-bid offers to provide full-requirements load-following wholesale electricity to these non-shopping customers. 3 The RFPs in these solicitations share some characteristics, such as clearly defining the electricity product being purchased and the rules governing the purchase, but often differ in important ways, including the structure of the sealed-bid offers and the method of determining the winning bids. However, these “auction design” details—the structure of the sealed-bid offers and the method for determining the winning bids—play a crucial role in determining the price at which wholesale power supplies will be purchased and hence the rate that non-shopping customers will pay for electricity.

Three auction design elements—tranche size ( i.e., the size of each unit of the power product being purchased), bid format, and auction clearing methodology—play a particularly important role in determining the price that these RFPs return. Sealed-bid auctions that allow for flexibility in the pricing structure can yield lower prices for electricity than other formats.

Sealed-Bid Auctions

Many jurisdictions use sealed-bid auctions to purchase a particular type of default electricity product referred to as full-requirements load-following power supply. 4 Take for example, sealed-bid auctions for full-requirements load-following power supply carried out by 10 utilities in seven states where

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