Electricity Markets

Paper Session

Saturday, Jan. 7, 2017 10:15 AM – 12:15 PM

Hyatt Regency Chicago, Wrigley
Hosted By: Transportation and Public Utilities Group
  • Chair: Leopoldo E. Soto Arriagada, Federal Energy Regulatory Commission

Limits to Arbitrage in Electricity Market

John Birge
,
University of Chicago
Ali Hortacsu
,
University of Chicago and NBER
Ignacia Mercadal
,
University of Chicago
Michael Pavlin
,
Wilfrid Laurier University

Abstract

As in most commodities markets, deregulated electricity markets allow the participation of purely financial (virtual) traders to enhance informational and productive efficiency. The presence of financial players is expected, among other things, to help eliminate predictable pricing gaps between forward (day-ahead) and spot prices, which may arise in the presence of market power by physical suppliers or buyers. However, we find that the impact of financial players on reducing pricing gaps has been limited. A forward premium persists. We show that financial traders indeed decrease the difference between the spot and forward prices, but arbitrage is limited by three barriers. First, arbitrageurs do not have unlimited access to capital. Trading was reduced during the financial crisis, when capital availability was restricted. The second is regulation, the regulator imposed high charges on some transactions and introduced uncertainty over how charges would be calculated and thus reduced virtual trading. Lastly, large financial players may find it more attractive to use financial bids to improve their position in a related market. We observe that some large financial players appear to be betting in exactly the opposite direction of the pricing gap, sustaining large losses while doing so. We find evidence consistent with participants using forward market bids to affect congestion and thus increase the value of their Financial Transmission Rights (FTR), i.e. these financial players incur losses with one financial instrument to make larger profits with another, introducing artificial congestion to the system.

The Long-Run Price Elasticity of Electricity Demand

Tatyana Deryugina
,
University of Illinois-Urbana-Champaign
Alexander MacKay
,
Harvard University
Julian Reif
,
University of Illinois-Urbana-Champaign

Abstract

Predicting the effects and incidence of climate change policy requires understanding how consumers respond to electricity prices. To date, studies of long-run electricity demand have relied on price changes that are transient or endogenous, and none have utilized experimental or quasi-experimental variation. We estimate the short-run (one-year) and long-run (three-year) price elasticity of residential electricity demand by exploiting price variation arising from a natural experiment: an Illinois policy that enabled some communities to select new electricity suppliers on behalf of their residents. Employing a flexible matching approach, we find that participating communities experienced long-lasting average price decreases in excess of 10 percent in the three years following adoption of a new supplier. Our estimates imply a short-run average price elasticity of -0.14 and a long-run elasticity of -0.29. We also present evidence that consumers reacted in anticipation of these price changes: usage began changing after the policy announcement but prior to the price change, which is consistent with a durable or habit good model of consumption. Our results demonstrate the importance of accounting for long-run adjustments when projecting the effects of climate change policies.

Strategic Ability and Productive Efficiency in Electricity Markets

Ali Hortacsu
,
University of Chicago and NBER
Fernando Luco
,
Texas A&M University
Steven L. Puller
,
Texas A&M University
Dongni Zhu
,
Texas A&M University

Abstract

Standard oligopoly models of short-run price competition in oligopoly settings predict that large firms can exercise market power and generate inefficiencies. However, productive inefficiency can also arise from other sources as well, such as in the presence of heterogeneity is strategic sophistication. This paper studies such a setting in the Texas electricity market, in which bidding behavior of some firms persistently and significantly deviates from Nash-equilibrium bidding. We leverage a unique dataset that contains information on bids and valuations to identify and estimate levels of strategic sophistication. We do this embedding a Cognitive Hierarchy model into a structural model of bidding behavior. (Preliminary) results show that larger firms have higher levels of strategic sophistication than smaller firms, though there is significant heterogeneity across firms. We then use the estimated distribution of types of strategic sophistication to perform counterfactual calculations about market efficiency under different scenarios that increase strategic sophistication of low-type firms either exogenously or through mergers with more sophisticated firms. We find that exogenously increasing sophistication of small firms increases productive efficiency. Furthermore, mergers that do not generate cost synergies and increase concentration may also increase efficiency.

The Long-Run Impact of Environmental Policies on Wholesale Electricity Markets: A Dynamic Competitive Analysis

Joseph A. Cullen
,
Washington University-St. Louis
Stanley S. Reynolds
,
University of Arizona

Abstract

We develop a dynamic competition model of wholesale electricity markets that incorporates supply side frictions in the form of minimum generation rates and generation unit startup costs. Such frictions may have a large impact on wholesale market prices,output decisions, and generator profits. We prove an equivalence between competitive market equilibrium and the solution to a planner’s dynamic programming problem. This planner’s problem provides a computational platform for the model. We parameterize our model based on Energy Information Administration data on new power plants and demand and renewable energy data from the Electric Reliability Council of Texas. We use the resulting model to assess the impact of carbon prices on capacity investment, emissions, and power plant operations. We report three main findings. First,the ability of an electricity system to respond to a carbon price in the short-run with fixed generating capital is limited. However in the long-run, even a modest price on carbon can have a dramatic effect on emissions through reinvestment in capacity. Second, without subsidies, investment in renewables is limited by their intermittent production and by the dynamic constraints of conventional generators even under relatively high carbon prices. Finally, a static model that does not account for dynamic constraints for generators grossly overstates investment in renewable energy and mischaracterizes the impact of a carbon price on emissions.
Discussant(s)
Dallas Burtraw
,
Resources for the Future
Rimvydas Baltaduonis
,
Gettysburg College
Karen Palmer
,
Resources for the Future
Ignacia Mercadal
,
University of Chicago
JEL Classifications
  • L2 - Firm Objectives, Organization, and Behavior
  • L9 - Industry Studies: Transportation and Utilities