An Experimental Test of Automated Market Power Mitigation Finds the Procedures Work

Michael Giberson

The new International Journal of Industrial Organization is a special issue devoted to experimental analysis. Among the articles is research into automated market power mitigation procedures similar to the rules employed in the New York Independent System Operator. In brief, the authors find that automated conduct- and impact-based screening of offers succeeded in mitigating the effects of attempts to exercise market power on power prices, at least when suppliers don’t have market power during periods that transmission lines are not congested. (Reference offer prices are determined by offers made during non-congested periods, so if generators have significant market power in these periods the reference offer prices can be manipulated upwards.)

The article, “An experimental test of automatic mitigation of wholesale electricity prices,” was authored by Daniel Shawhan, Kent Messer, William Schulze, and Richard E. Schuler.

ABSTRACT: In several major deregulated electricity generation markets, the market operator uses an “automatic mitigation procedure” (AMP) to attempt to suppress the exercise of market power. A leading type of AMP compares the offer price from each generation unit with a recent historical average of accepted offer prices from that same unit during periods when there was no transmission-system congestion to impede competition. If one or more units’ offer prices exceed the recent historical average by more than a specified margin, and if these offer prices raise the market-clearing price by more than a specified margin, the market operator replaces the offending offer prices with lower ones. In an experiment, we test an AMP of this type. We find that it keeps market prices close to marginal cost if generation owners have low market power in uncongested periods. However, with high market power in uncongested periods, a condition that may apply in many parts of the world, the generation owners are able to gradually raise the market price well above short-run marginal cost in spite of the AMP. We also test the effect of the AMP on the frequency with which high-variable-cost units are used, inefficiently, in place of low-variable-cost units.

Interested readers should also note related research by Lynne Kiesling and Bart Wilson, “An experimental analysis of the effects of automated mitigation procedures on investment and prices in wholesale electricity markets,” Journal of Regulatory Economics, 2007.

(HT to Al Roth and his Market Design blog.)