Citation:
Abstract:
The rapid growth in energy trading and movement towards deregulation of electricity markets have come to a halt in the wake of assertions that western U.S. energy markets were manipulated. This paper refocuses attention on the potential efficiency gains from competitive wholesale power trading, showing that for any given level of average demand, retail electricity prices will be lower if electricity is traded in competitive wholesale markets than if electricity is delivered by integrated producer-retailers. Wholesale power trading allows for the diversification of demand risk, and the greatest efficiency gains accrue when power demand is least correlated across markets and when there is substantial geographic variation in expected demand. Simulation evidence indicates that real time power trading could reduce retail prices by conservative estimates of 3 to 4% on average in the U.S., and that the combination of forward and real time trading could reduce prices by 6 to 10% or more. This analysis indicates that economic efficiency would be best served by policy aimed at ensuring that power markets are indeed competitive, and that sufficient transmission capacity exists for profitable power trades to be completed.