Financial Arbitrage and Efficient Dispatch in Wholesale Electricity Markets

MIT Center for Energy and Environmental Policy Research No. 15-002

57 Pages Posted: 7 Mar 2015

See all articles by John E. Parsons

John E. Parsons

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Cathleen Colbert

Government of the United States of America - Federal Energy Regulatory Commission

Jeremy Larrieu

George Washington University - Department of Economics

Taylor Martin

Government of the United States of America - Federal Energy Regulatory Commission

Erin Mastrangelo

Government of the United States of America - Federal Energy Regulatory Commission

Date Written: February 10, 2015

Abstract

Virtual bidding is a type of transaction introduced into wholesale electricity markets to improve competition and pricing. This paper analyzes the theory behind virtual bidding and describes circumstances under which it does not work as advertised. The case for virtual bidding is predicated on an oversimplified model of the multi-settlement market design. The complexity of the unit commitment and optimal power flow problems forces the actual market algorithms to make compromises with the theoretical model. These compromises create situations in which virtual bidders can profit without improving system performance. Indeed, in these situations, virtual bidding can add real costs to system operation. The paper illustrates this with a specific case study of virtual bidding in California, and with a matching numerical illustration. The paper explains the general nature of the problem with experiences in other regions and other situations. The fault with virtual bidding identified in this paper needs to be incorporated into any assessment of the costs and benefits of virtual bidding.

Keywords: financial arbitrage, efficient dispatch, virtual bidding, wholesale electricity markets

JEL Classification: D43, G10, L51, L94

Suggested Citation

Parsons, John E. and Colbert, Cathleen and Larrieu, Jeremy and Martin, Taylor and Mastrangelo, Erin, Financial Arbitrage and Efficient Dispatch in Wholesale Electricity Markets (February 10, 2015). MIT Center for Energy and Environmental Policy Research No. 15-002, Available at SSRN: https://ssrn.com/abstract=2574397 or http://dx.doi.org/10.2139/ssrn.2574397

John E. Parsons (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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Cathleen Colbert

Government of the United States of America - Federal Energy Regulatory Commission ( email )

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Jeremy Larrieu

George Washington University - Department of Economics ( email )

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Taylor Martin

Government of the United States of America - Federal Energy Regulatory Commission ( email )

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Erin Mastrangelo

Government of the United States of America - Federal Energy Regulatory Commission ( email )

881 1st Street NE
Washington, DC 20426
United States

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