Uniform pricing or pay-as-bid pricing: A dilemma for california and beyond

Electricity Journal

Volumn 14, Issue 6, 2001, Pages 70-79

  Kahn, Alfred E ^c   Cramton, Peter C ^a   Porter, Robert H ^c   Tabors, Richard D ^b  

^a UNIVERSITY OF MARYLAND   (United States)

^b Tabors Caramanis and Associates   (United States)

^c NONE

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[No Author keywords available]

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EID: 0035402155     PISSN: 10406190     EISSN: None     Source Type: Journal    
DOI: 10.1016/S1040-6190(01)00216-0     Document Type: Article

References (17)

1. 1. In most cases, the marginal opportunity cost is just the incremental cost of generating additional energy. For hydro power, however, it has little to do with physical operating costs, consisting rather of the revenue or value sacrificed by using or selling it today rather than later, or in one place in California rather than elsewhere, both of which depend in turn on how full the reservoirs are and expectations about future prices. Even for fossil and nuclear plants, the marginal opportunity cost may differ from incremental operating costs to the extent there are opportunities to sell the energy in other markets in and out of California.
2. 2. The U.S. Treasury conducted an experiment, in which it employed both uniform pricing and pay-as-bid mechanisms in the sale of Treasury bills. It found mixed results, and could not conclude that the average winning bid prices of the two mechanisms differed significantly. See, for example, Christine M. Archibald and Paul F. Malvey, Uniform-Price Auctions: Update of the Treasury Experience, working paper, U.S. Treasury, 1998; and Gregory Belzerand Vincent Reinhart, Some Evidence onBid Sharing and the Use of Information inthe U.S. Treasury's Auction Experiment,working paper, Board of Governors ofthe Federal Reserve System, 1996.
3. 2. The U.S. Treasury conducted an experiment, in which it employed both uniform pricing and pay-as-bid mechanisms in the sale of Treasury bills. Itfound mixed results, and could notconclude that the average winningbid prices of the two mechanisms differed significantly. See, for example,Christine M. Archibald and Paul F.Malvey, Uniform-Price Auctions: Update ofthe Treasury Experience, working paper,U.S. Treasury, 1998; and Gregory Belzer and Vincent Reinhart, Some Evidence on Bid Sharing and the Use of Information in the U.S. Treasury's Auction Experiment, working paper, Board of Governors of the Federal Reserve System, 1996.
4. 3. See, for example, Eric Maskin and John Riley, Asymmetric Auctions, Rev. Econ. Studies, July 2000, at 413-438.
5. 4. See, for example, Paul Joskow and Edward Kahn, A Quantitative Analysis of Pricing Behavior In California's Wholesale Electricity Market During Summer 2000, National Bureau of Economic Research (NBER), Cambridge, MA, Working Paper No. 8157, March 2001; Robert Nordhaus, Carl Shapiro, and Frank A.Wolak, An Analysis of the June 2000 PriceSpikes in the California ISO's Energy andAncillary Services Markets, Sept. 6, 2000; and Severin Borenstein, James Bushnell,and Frank Wolak, Diagnosing MarketPower in California's Restructured Wholesale Electricity Market, NBER WorkingPaper No. 7868, Sept. 2000.
6. 4. See, for example, Paul Joskow andEdward Kahn, A Quantitative Analysis ofPricing Behavior In California's WholesaleElectricity Market During Summer 2000,National Bureau of Economic Research(NBER), Cambridge, MA, WorkingPaper No. 8157, March 2001; Robert Nordhaus, Carl Shapiro, and Frank A. Wolak, An Analysis of the June 2000 Price Spikes in the California ISO's Energy and Ancillary Services Markets, Sept. 6, 2000; and Severin Borenstein, James Bushnell,and Frank Wolak, Diagnosing MarketPower in California's Restructured Wholesale Electricity Market, NBER WorkingPaper No. 7868, Sept. 2000.
7. 4. See, for example, Paul Joskow andEdward Kahn, A Quantitative Analysis ofPricing Behavior In California's WholesaleElectricity Market During Summer 2000,National Bureau of Economic Research(NBER), Cambridge, MA, WorkingPaper No. 8157, March 2001; Robert Nordhaus, Carl Shapiro, and Frank A.Wolak, An Analysis of the June 2000 PriceSpikes in the California ISO's Energy andAncillary Services Markets, Sept. 6, 2000; and Severin Borenstein, James Bushnell, and Frank Wolak, Diagnosing Market Power in California's Restructured Wholesale Electricity Market, NBER Working Paper No. 7868, Sept. 2000.
8. 5. It might appear that the effect of such exertions of market power would be indistinguishable from the effect of a rising peak demand in a situation of inadequate capacity even under pure or perfect competition: Firms with no market power would likewise be expected to withhold capacity in expectation of soaring competitive prices. That would indeed be expected in any other industry, in which supplies withheld today can be sold tomorrow at prices increased by such withholding. It would not be true, however, in the case of electric power. Power (except hydro) that is not offered in the market today cannot be stored and offered tomorrow. The small generator who withholds in this way simply loses the sales it could have made today. Only a generator with aggregate capacity greater than the anticipated shortage could profit by sacrificing some portion of the sales it is physically capable of making in the expectation of gaining more from the consequent increase in the difference between the newly elevated market price and its own marginal costs on the sales that it continues to make. On the other hand, the fact that prices at such times may exceed the marginal operating costs of the least efficient generator in use - the usual indicator of monopolistic withholding of output -does not in itself prove that such withholding has occurred: When demand reaches the absolute physical limit of capacity - i.e., supply becomes totally unresponsive to price - the competitive price will rise to whatever level necessary to reduce the quantities demanded to that fixed supply.
9. 6. This risk is not great at peak times, when there is little aggregate excess capacity. It is much greater off-peak.
10. 7. See, for example, Giulio Federico and David Rahman, Bidding in an Electricity Pay-as-Bid Auction, occasional paper, Nuffield College, Oxford, U.K., and University of California at Los Angeles, for submission to California Power Exchange Blue Ribbon Panel, Nov. 2000.
11. 8. Natalia Fabra, Uniform Pricing Facilitates Collusion: The Case of Electricity Markets, occasional paper, European Univ. Institute, for submission to California Power Exchange Blue Ribbon Panel, Oct. 2000; and Carlos Vazquez, Michel Rivier,and Ignacio J. Perez-Arriaga, On the Useof Pay-as-Bid Auctions in California: SomeCriticisms and an Alternative Proposal, IITWorking Paper IIT-00-077A, Nov. 2000.
12. 8. Natalia Fabra, Uniform Pricing Facilitates Collusion: The Case of Electricity Markets, occasional paper, European Univ.Institute, for submission to CaliforniaPower Exchange Blue Ribbon Panel, Oct.2000; and Carlos Vazquez, Michel Rivier, and Ignacio J. Perez-Arriaga, On the Use of Pay-as-Bid Auctions in California: Some Criticisms and an Alternative Proposal, IIT Working Paper IIT-00-077A, Nov. 2000.
13. 9. This may appear to be an odd kind of deregulation. The essential premise of deregulation is, however, that competition will effectively protect consumers from monopoly. If the inadequacy of capacity, in confrontation with an extremely inelastic demand, has created opportunities for the exertion of such power, it would be blindly ideological simply to refuse to proceed against such manipulations, while taking pains not to interfere with the longer-term corrective of additions to capacity and more effective efforts to curtail demand and make it more elastic.
14. 10. The IOUs were able to purchase via forward contracts through the CalPX -but only through the PX - after it first made block forward contracts available in July 1999. Although there are regulatory limits on the amount of forward positions that each IOU may take, they have not reached those limits in availing themselves of this opportunity. They may have been discouraged from doing so by their past experience with forward purchases in California, in both gas and electric, under which regulators forced them to absorb any losses stemming from the contract prices exceeding wholesale market prices while not being permitted to reap the benefits when the contractual prices were lower. In any event, what the IOUs are vociferously seeking is the ability to negotiate contracts directly with generators.
15. 11. We consider both the day-ahead and real-time markets to be spot markets. Energy contracted more than one day in advance is traded in forward markets.
16. 12. "An essential remedy is the elimination of rules that prevent market participants from managing their risks. Moving significant amounts of wholesale transactions into forward markets will (1) reduce reliance on spot markets, thereby directly reducing both the likelihood and the adverse economic consequences of pricing volatility; (2) eliminate the adverse reliability impacts that the ISO faces each day as its obligation to operate a real-time balance market has become transformed into operating the major commodity exchange at the last minute; (3) increase the likelihood of new generation entry because the uncertain revenue stream from spot markets will not attract the necessary capital investments; and (4) limit the ability of sellers to exercise market power in spot markets." Federal Energy Regulatory Commission, Order Proposing Remedies for California Wholesale Electric Markets, Docket No. EL00-95-000, Washington, DC, Nov. 1, 2000, at 21.
17. 13. The MSC contended additionally that the ability and/or incentive of generators to exercise market power in spot markets is increased by the absence of a significant amount of forward contracting. See, for example, Robert Nordhaus, Frank A. Wolak, and Carl Shapiro, Analysis of "Order Proposing Remedies for California Wholesale Electric Markets (issued November 1, 2000)," Market Surveillance Committee of the California Independent System Operator, Dec. 1, 2000, at 27-28, ftp://zia.stanford.edu/pub/ papers/MSCDEC01.pdf or http:// www.caiso.com/docs/2000/12/01/ 2000120116120227219.pdf (July 6, 2001).