Reforming Bulk Power Auctions: Why Not Pay According to Bid?

 

Changing settlement rules might offer a fix for broken power markets.

Before consumers endure yet another summer of tenuous reliability and high electricity prices, perhaps it is time to consider changing the rules of the game. One such rule is the common practice in regional electricity spot markets whereby the last (highest) accepted supply bid sets the clearing price for all generators. Does this practice, known as a "uniform price auction," make spot markets more vulnerable to anti-competitive behavior and the abuse of market power?

In fact, some experts have suggested that the likelihood of market power abuse depends, to some degree, on the settlement rule used to determine payments in wholesale auctions. They suggest that the exercise of market power is likely when auctions adopt uniform pricing-i.e., "last bid sets price"-in a market with high demand and low supply.1# The analysis I offer here appears to confirm this theory. More importantly, my analysis suggests that a "discriminatory price auction"—i.e., "pay according to bid"—might offer a better approach for reducing prices in bulk power markets.

This article evaluates both types of auction settlement rules: (1) "last bid sets price," by which the last offer accepted determines the price paid to all participants; and (2) the "pay as bid" model, by which each participant is paid the amount bid by that party. By modeling the markets for energy and various ancillary services in a large control area, it is demonstrated that under conditions of market power, substantial revenues with commensurately high profits can be commanded under a "last bid sets price" price auction.