Electricity market manipulation enforcement actions have moved from conventional analysis of generator market power in real-time physical markets to material allegations of sustained crossproduct price manipulation in forward financial markets. A major challenge is to develop and apply forward market analytical frameworks and models. This task is more difficult than for the real-time market. An adaptation of cross-product manipulation models from cash-settled financial markets provides an existence demonstration under uncertainty and asymmetric information. The implications of this analysis include strong empirical predictions about necessary randomized strategies that are not likely to be observed or sustainable in electricity markets. Absent these randomized strategies and other market imperfections, the means for achieving sustained forward market price manipulation remains unexplained.
Keywords: market manipulation; electricity markets; limits to arbitrage; asymmetric information
This paper examines carbon tax design options in the United States using an intertemporal computable general equilibrium model of the world economy called G- Cubed. Four policy scenarios explore two overarching issues: (1) the effects of a carbon tax under alternative assumptions about the use of the resulting revenue, and (2) the effects of a system of import charges on carbon-intensive goods (“border carbon adjustments”).
Electricity markets employ open access and non‐discrimination to foster competition, market entry, and innovation. The physical characteristics of the electricity system require explicit consideration of key elements in electricity market design. Pricing and settlement rules for the real‐time market must provide efficient incentives, both for short‐term operations and long‐run investment. The ERCOT energy‐only market design emphasizes the need to get the real‐time prices right.The recent innovation of the ERCOT Operating Reserve Demand Curve (ORDC) addressed the fundamental problem of inadequate region‐wide scarcity pricing that has plagued other organized markets, which have exhibited inadequate incentives both for reliable operations and efficient investment.
ERCOT employs an open wholesale electricity market as the basis for short‐term reliable electricity supply as well as for long‐term investments to maintain reliability in the future. A review of energy price formation in ERCOT leads to two important conclusions: (i) while the ORDC is performing consistently within its design, scarcity price formation is being adversely influenced by factors not contemplated by the ORDC; (ii) other aspects of the ERCOT market design must be improved to better maintain private market response to energy prices as the driver of resource investment, maintenance expenditure and retirement decisions.
The paper identifies three general issues that have affected ERCOT energy prices in recent years, and recommends policy and price formation improvements consistent with efficient market design. These recommendations cannot reverse the impact of broader economic trends, such as low natural gas prices, or national policies, such as subsidies for investments in renewable resources. However, the stress of these forces has exposed areas where there is a need for adjustments to pricing rules and policies within ERCOT.
This paper estimates changes in electricity generation costs caused by the introduction of market mechanisms to determine output decisions in service areas that were previously using command-and-control-type operations. I use the staggered transition to markets from 1999- 2012 to evaluate the causal impact of liberalization using a nationwide panel of hourly data on electricity demand and unit-level costs, capacities, and output. To address the potentially confounding effects of unrelated fuel price changes, I use machine learning methods to predict the allocation of output to generating units in the absence of markets for counterfactual pro- duction patterns. I find that markets reduce production costs by $3B per year by reallocating output among existing power plants: Gains from trade across service areas increase by 20% based on a 10% increase in traded electricity, and costs from using uneconomical units fall 20% from a 10% reduction in their operation.
Excerpt from the Executive Summary:
Organized wholesale electricity markets were created to address burgeoning costs of new power generation under the traditional regulatory scheme and to encourage innovation through free-enterprise competition. The discipline of the marketplace promised lower costs and greater efficiencies. Two decades of experience and numerous studies have demonstrated competitive wholesale markets in PJM and elsewhere bring increased operational efficiency and innovation, resulting from transparent market prices and the benefits of single, independent dispatch across a broad region. These benefits are realized through economies of scale that permit optimization of a large and diverse set of resources and load. The resulting efficiencies are measured in reduced heat rates and increased capacity factors.
However, as a host of organic and external factors change the power supply landscape, some have questioned the efficacy of competitive wholesale markets at promoting the most efficient entry and exit of resources – especially compared to traditional utility regulation with administrative planning and direction, such as under a state-integrated resource plan. Various forces, including federal and state public policies, low-priced domestic natural gas and static or declining levels of wholesale electricity consumption, have challenged incumbent or “legacy” generation resources by increasing operating costs, creating capital investment needs and reducing revenues realized in PJM’s energy, capacity and ancillary service markets. For the least efficient of these resources – older, small coal units, single-unit nuclear stations and older, high-heat-rate natural gas and oil-fired generation – these cost and revenue pressures have threatened their ongoing viability and not unexpectedly have led to retirements in many cases.
Consequently, some observers have questioned whether wholesale markets have forced premature retirements of viable legacy generating resources and whether markets can be relied upon to ensure adequate power supplies in light of the retirements. The questions raised with regard to decisions and outcomes related to the changing nature of the supply portfolio in PJM can be summarized as:
Can we rely on PJM’s organized wholesale electricity market to efficiently and reliably manage the entry and exit of supply resources as external forces create tremendous uncertainty and potential industry transformation?
The goal of this paper is to answer this question. In doing so, this paper does not present itself as an exhaustive or scientific analysis of what are complex issues characterized by numerous variables. In some cases, the value proposition brought to the generation investment decision by competitive markets can be shown with a high degree of confidence. In other cases, the relative advantage of a competitive versus a regulated paradigm in efficiently bringing in new generation and exiting inefficient generation is more arguable. Finally, certain challenges and difficult outcomes necessarily result from the operation of PJM markets in driving investment decisions – challenges and difficulties involving choices between often-competing social and political interests. In contrast, when investment decisions are driven by utilities and their regulators, a trade-off between diverging policy interests can be made directly and explicitly, though not necessarily from a well-informed understanding of the trade-off.
Summary Efficient electricity day-ahead market designs include virtual transactions. These are financial contracts awarded at day-ahead prices and settled at real-time prices. In PJM these virtual transactions include incremental offers (INCs) that are like generation offers, decremental bids (DECs) that are like demand bids, and up-to-congestion bids (UTCs) that are like transmission price spread bids. Virtual transactions offer potential benefits to improve the efficiency of electricity markets, mitigate market power, enhance price formation, hedge real-time market risks, and price those risk hedging benefits.
The role and performance of virtual transactions has been a subject of controversy. A report by PJM addresses some of these controversies, identifies possible problems in the present implementation of virtual transactions with the associated settlement rules, and makes recommendations for changes in the treatment of virtual transactions. The PJM report is generally supportive of the contribution of virtual transactions as improving overall market performance. Illustrative examples in the report highlight these contributions and add to the general understanding of the benefits and some of the problems with its current rules for treating virtual transaction.
Although these examples help in explaining the mechanics of virtual transactions, and the interactions with the underlying physical market, the examples do not provide a framework for evaluating the overall cost and benefits of virtual transactions. The PJM analysis is not alone in this regard, because the evaluation task is not easy. There is no readily available template waiting to be applied to the PJM case. The limited available analyses from other regions indicate that the benefits are material and outweigh the costs, but no available studies cover all the relevant issues. However, going beyond examples of particular outcomes to consider, the broader context is important. Looking to the broader framework can change both the diagnosis of the symptoms and the prescriptions for the cures.
Under the current PJM market rules, there is an asymmetry in the settlement treatment of different types of virtual transactions, applying residual uplift charges to INCs and DECs but not to UTCs. One of the PJM recommendations is to eliminate this asymmetry by extending the same uplift treatment to UTCs. The argument is based on allocation of uplift costs according to the deviations between real-time quantity and day-ahead schedules. This approach is particularly problematic for virtual transactions, which by design involve a 100% deviation.
There is no simple connection between deviations, uplift costs and market efficiency. Under a broader equilibrium analysis there can be conditions where there is no relationship between any of these components. Furthermore, the allocation of properly defined residual costs according to a cost causation argument can in itself be a contradiction. More importantly, the focus on uplift cost causation is misplaced. The important question is the aggregate net benefit of virtual transactions, not the residual cost. If virtual transactions increase the net benefits in the market, then there is no incentive-based reason to assign additional costs to virtual transactions. The iii criterion for assigning residual costs would then turn to doing the least damage to the performance of the market.
A better symmetric solution is to avoid any uplift allocation to virtual transactions. The residual cost allocation would then apply to real load; liquidity and entry in financial day-ahead virtual transactions would be enhanced; market power would be reduced; accurate price formation would be supported; and the efficiency of the overall PJM electricity market system should be improved. This reversal of the conventional wisdom follows from a broader framework than that applied by PJM for consideration of the costs and benefits of virtual transactions.
This broader framework builds directly on the basic principles of efficient electricity market design. Stepping back to consider first principles makes it easier to see the connections among the components of market design, in order to consider the function and benefits of virtual transactions from the perspective of aggregate market performance. PJM’s own analysis provides many examples of the contributions and effects of virtual bidding, but does not connect the examples to the broader framework of electricity market design principles. Furthermore, going beyond the uplift allocations, the PJM recommendations restricting the use of virtual transactions do not follow necessarily even from a narrower evaluation perspective. The principal problem PJM identifies with virtual transactions is a computational burden that would be only indirectly affected by uplift allocations, and could be addressed through other means with fewer negative consequences for the broader market design, such as by continuation of bidding budgets that allowed flexibility in the choice of virtual transactions.
Restricting explicit virtual bidding, as PJM proposes, creates market power for those who can make implicit virtual bids. Explicit virtual bidding mitigates or eliminates this market power, provides liquidity, improves price formation, allows hedging, connects naturally with longer term financial transmission rights, helps reveal defects in market design, and on average should improve system operations.
The PJM report appears in a context where virtual bidding is under attack. While a complete cost benefit analysis is not available, the PJM analysis can be expanded to enhance both the understanding of the role of virtual bidding and the policies that support overall electricity market efficiency.
Excerpt from the Executive Summary:
This white paper (paper) describes the design of a new, distribution level market for energy and related electric products from Distributed Energy Resources (DER) and of a statewide digital Platform to animate and facilitate the financial transactions in that market. Tabors Caramanis Rudkevich (TCR) has prepared this paper as an input to the Reforming the Energy Vision (REV) proceedings of the New York State Public Service Commission (the Commission). The paper presents the rationale for establishing this new market structure, explains how the establishment of a digital platform would support the operation of the market, and describes the steps required to implement the Platform and Platform Market.