New Studies Address Misperceptions about Electricity Markets

The single price clearing auction, a central feature of competitive electricity markets, helps to efficiently allocate generation resources on a least-cost basis and is superior to proposed alternatives, according to a new study released today.

Click here to listen to an audio file of the presentation.

“Electricity markets should maintain the single price rule that is standard in organized markets in the United States,” concludes the study, Single Clearing Price in Electricity Markets, by Ross Baldick of The University of Texas at Austin. A proposed alternative to the single clearing price auction, in which sellers are paid their bid price rather than the auction’s clearing price, would impair the efficient dispatch of generation and make it more difficult to police against the exercise of market power, Baldick warned.

Further, the study rejected unsupported arguments that pay-as-bid would result in lower electricity prices. “Claims that pay-as-bid might improve the performance of electricity markets are unsupported,” Baldick concluded in his study.

Baldick’s findings were echoed in another paper released today, Market Misperceptions and Regrets about Past Business Decisions, by Roy Shanker, a long-time expert consultant in the electric utility sector. “Worldwide, virtually all commodity markets operate in a manner that reflects the so called “law of one price” with effectively a single clearing price adjusted for location,” Shanker concluded in his analysis. His paper concludes that most of the criticisms of electricity markets today are more about past bad business decisions than about the actual market designs.

“The main argument against a single clearing-price auction is political, not economic,” observed University of Maryland economist Peter Cramton in a foreword to the Baldick paper. Cramton, an expert on auction theory and practice, noted that when electricity prices are high, critics point to the disparity between the clearing price and the marginal cost of generators using less expensive fuel. “What they fail to appreciate is that these higher profits of the low-cost generators are needed to cover the much higher fixed-costs of these resources that use less expensive fuel, such as hydro, nuclear, solar and wind. In addition, the higher spot price motivates the demand side to conserve.”

The U.S. Court of Appeals for the District of Columbia Circuit emphasized these benefits in a recent opinion rejecting a lawsuit seeking to reinstate regulated cost-based pricing in the New England electricity market (http://pacer.cadc.uscourts.gov/docs/common/opinions/200901/07-1130-1160521.pdf):

“[T]he high returns earned by low-cost generators charging market rates provide an incentive for the development of new generation facilities as well as increased efficiency on the part of existing generators. Furthermore, higher prices are likely to affect consumers’ behavior, reducing the strain on the system created by high demand,” the appeals court panel found. “At the same time that they reflect existing scarcity, these high rates also serve a critical signaling function: encouraging new development that will increase supply.”

Also released today by the COMPETE Coalition was a study, Contracting and Investment: A Cross-Industry Assessment, by Robert Stoddard of CRA International, addressing misperceptions about the role of long-term contracts in incentivizing capital investments.

“Some argue that regulated utilities should build the new generation, recovering the costs in regulated states,” Stoddard said. “Others believe that generators and utilities will need to enter into these contracts for new generation to be built. But you can get capital intensive infrastructure investment spent without long-term contracts provided that you have fair and robust markets for commodity-like products.”

Stoddard’s study addresses the arguments for and against long-term contracting by examining the need for long-term contracts, or lack thereof, between producers and end-use customers in several industries. The examination concludes that these contracts are not essential to assuring orderly investment in industries that resemble electric power generation.

The papers released today, as well as overviews by the authors, are available below:

Comments on RTO Market Design and Pricing: Three Perspectives (powerpoint presentation)

Professor Ross Baldick: Single Clearing Price in Electricity Markets

Roy Shanker, Ph.D.: Market Misperceptions and Regrets about Past Business Decisions

Robert Stoddard, CRA International: Contracting and Investment: A Cross-Industry Assessment

Contracting and Investment: A Cross-Industry Assessment (powerpoint presentation)