William W. Hogan
2018
Mar
22
The California Meltdown
Externalities and Incentives.” In, 2009.Abstract
“Organized electricity markets often require submission of supply functions ahead of the realization of uncertain demand. As a model of oligopoly behavior, the Nash condition of supply function equilibrium has a natural appeal. Typically this produces a continuum of possible equilibria, presenting an equilibrium selection problem. Beyond existence, stability of an equilibrium would be an obvious criterion for selection. For affine demand and marginal costs, polynomial approximation provides an approach for analyzing the stability of unconstrained supply function equilibria. The set of stable approximation equilibria is small and its properties suggest that the set of stable exact supply function equilibria is empty.
Executive Summary:
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.