Gaming and price spikes in electric power markets and possible remedies

Summary form only given as follows. Many challenging issues arise under the newly deregulated competitive electric power markets. Instead of centralized decision-making in a vertically integrated environment as in the past, decision-making is now decentralized and driven by market forces. The collapse of the California PX market in early 2001 fostered a lot of debates on the fundamental issues in deregulating electric power markets. Among the most important reasons that cause the collapse of the California market, we focus on our discussion on gaming and price spikes. In fact these phenomena have been observed in almost every electricity market but explicit analysis of them is rare. In this paper, we examine historical bid curves from the original California day-ahead energy market. These curves have the property that slight shifts in either the supply offer or demand bid can cause large changes in the market clearing price. Based on this observation, we formulate a Prisoner\´s dilemma matrix game to show that suppliers have incentive to withhold capacity from the market. That is, under certain conditions, enough suppliers independently withholding capacity can shift the aggregated supply curve to cause a price spike. We call this phenomenon "opportunistic tacit collusion" to distinguish it from the classical "tacit collusion" that occurs in static repeated Prisoner\´s dilemma games, where the object is for all players to learn that they can always make excess profits if they withhold a small amount of capacity from the market. Once this is learned suppliers "tacitly collude" to sustain high market prices. We assert, however, that it is not always profitable to withhold capacity from the market, since the opportunity for raising profits does not always exist due to externalities such as the demand bid, network loading, power imports, prices in other markets, etc. In other words, the payoff\´s in the payoff matrix change with the externalities, making it necessary to recognize when the "opportunity" to drive up profits exists. When enough suppliers recognize the opportunity we get "opportunistic tacit collusion." As we explain, this gaming behavior can take place independently of market power, transmission constraints, or insufficient supply, and is only enhan- ced by those factors. Price spikes from opportunistic tacit collusion can be expected to appear in any single price auction with price insensitive demand, a property that is typical of many electricity markets. Based on the above analysis, possible remedies are proposed. The attention is given to market design and bidding mechanism. The shortcomings of the current instant bidding rule is studied first and a new bidding rule and the associated market scheme are presented.