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Electricity Markets

Paper Session

Saturday, Jan. 5, 2019 2:30 PM - 4:30 PM

Hilton Atlanta, 303
Hosted By: Transportation and Public Utilities Group
  • Chair: Frank A. Wolak, Stanford University

Testing for Market Efficiency with Transaction Costs: An Application to Financial Trading in Wholesale Electricity Markets

Akshaya Jha
,
Carnegie Mellon University
Frank A. Wolak
,
Stanford University

Abstract

With risk neutral traders and zero transaction costs, the expected value of the difference between the current forward price and the spot price of a commodity at the delivery date of the forward contract should be zero. Accounting for the transaction costs associated with trading in these two markets invalidates this result. We develop a statistical framework to test whether profitable trading strategies exploiting systematic differences between spot and forward market prices exist in the presence of trading costs. We implement these tests using the day-ahead forward and real-time spot locational marginal prices from California’s wholesale electricity market. We use our statistical tests to construct an estimate of the variable costof trading in this market. During our sample period, we observe the introduction of financial trading, which was aimed at reducing the costs associated with exploiting differences between forward and spot prices. Consistent with this aim, our measures of trading costs are significantly smaller after the introduction of financial trading. Prior to financial trading, day-ahead/real-time price differences could be exploited more readily at locations where generation is injected (“generation nodes”). Consistent with this, our estimated trading costs are lower for generation nodes relative to non-generation nodes before financial trading and trading costs fell more for non-generation nodes after financial trading, eliminating any difference in trading costs across the two types of nodes. We also present evidence that the introduction of financial trading reduced the total amount of input fossil fuel energy required to generate the thermal-based electricity produced in California and the total variable of costs of producing this electrical energy. Taken together, these results demonstrate that purely financial forward market trading can improve the operating efficiency of short-term commodity markets.

Dynamic Competition and Arbitrage in Electricity Markets: The Role of Financial Traders

Ignacia Mercadal
,
Columbia University

Abstract

As in most commodities markets, deregulated electricity markets allow the participation of purely financial 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 and spot prices, which may arise in the presence of market power and are linked to productive inefficiency. However, we find that the impact of financial players on reducing pricing gaps has been limited, even using credibly exogenous variation in financial activity to address potential endogeneity. A forward premium persists. We show that financial traders effect on the premium was limited by two 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, as high transaction costs imposed by the regulator restricted arbitrage. Moreover, during this period we observe that some 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.

Who Benefits from Ratepayer-funded Auctions of Transmission Congestion Contracts? Evidence from New York

Gordon Leslie
,
Monash University

Abstract

Transmission congestion contracts are derivative products that electricity retailers can use to change their future wholesale electricity price exposure to a different location. U.S. Congress is concerned by financial trader profits in auctions for these derivatives because the payouts are funded by ratepayers, not willing counterparties. I study firm-level positions in the New York Wholesale Electricity Market to investigate the causes of this concern. I find a small set of financial traders earn large, systematic profits on products that electricity retailers tend to avoid. However, trader participation can improve price signals on these and related products. Policy implications are discussed.

Measuring the Impact of Purely Financial Participants on Wholesale and Retail Market Performance: The Case of Singapore

Frank A. Wolak
,
Stanford University

Abstract

In April 2015, Singapore introduced an anonymous futures market for wholesale electricity to increase competition faced by the vertically-integrated incumbent retailers. Four independent retailers subsequently entered. Using data on prices and other observable characteristics of all competitive retail contracts signed from October 2014 to March 2016, a larger average quantity of open futures contracts that clear during the term of the retail contract before the retail contract starts predicts a lower price for the retail contract. This outcome is consistent with increased futures market purchases by independent retailers causing lower retail prices. Consistent with the logic in Wolak (2000) that a larger volume of fixed-price forward contract obligations leads to offer prices closer to the supplier’s marginal cost of production, a larger volume of futures contracts clearing against short-term wholesale prices predicts lower half-hourly wholesale prices. Both empirical results support introducing purely financial players to improve both retail and wholesale market performance.
JEL Classifications
  • Q4 - Energy
  • Q5 - Environmental Economics