The Economics of Electricity Markets

Completed projects

Pro-competitive rationing in multi-unit auctions

Power exchanges need to specify rationing rules for cases when there is excess supply at the market clearing price. In this new research paper Pär Holmberg introduces a rationing rule that results in more competitive bids. The improvement is particularly large for auctions and exchanges where bid prices accumulate at a few price levels.

Download: Pro-competitive rationing in multi-unit auctions by Pär Holmberg

What is the impact of market-specific news on electricity prices?

This research paper studies the impact of market specific news, called urgent market messages, on the price differences between the day-ahead market, Elspot, and the intra-day market, Elbas, on the Nordic power exchange. A large part of the price differences can be explained by relevant information reaching the market after gate closure of Elspot at noon, but arriving in time to affect Elbas prices. For example, as much as 92% of the price differences can be explained by information about capacity problems in coal-fired power plants.

Download: Market-specific news and its impact on forward premia on electricity markets by Ewa Lazarczyk

How price spikes can help overcome the energy efficiency gap

Studies have shown that many consumers and businesses fail to invest in energy efficiency improvements despite seemingly ample financial incentives to do so – the so-called energy efficiency gap or paradox. Using data on Norwegian electricity prices and Google searches for heat pumps, this paper suggests that the inherently spikey nature of many electricity prices has a strong and significant positive effect on searching for information on energy efficient goods.

Download: How price spikes can help overcome the energy efficiency gap by Johannes Mauritzen

Strategic option trading may be anticompetitive

This research paper demonstrates how suppliers can take strategic speculative positions in derivative markets to soften competition in the spot market. This type of strategic speculation increases the level and volatility of commodity prices and decreases welfare.

Download: Relaxing competition through speculation: Committing to a negative supply slope by Pär Holmberg and Bert Willems

Nuclear capacity auctions

This research paper proposes nuclear capacity auctions as a means to improve the incentives for investing in nuclear power. A properly designed auction would (1) allocate the license to the most efficient bidder; (2) sell the license if and only if new nuclear power was socially optimal. In particular, capacity auctions open the market for large-scale entry by outside firms. Requiring licensees to sell a share of capacity as virtual power plant contracts increases auction efficiency by softening incumbent producers’ incentive to bid for market power. The motivating example is Sweden’s recent decision to allow new nuclear power to replace old reactors.

Download: Nuclear capacity auctions by Sven-Olof Fridolfsson and Thomas Tangerås

Renewable electricity policy and market integration

by Thomas Tangerås analyzes renewable electricity policy in a multinational electricity market with transmission investment. If national policy makers choose support schemes to maximize domestic welfare, then a trade policy motive arises operating independently of any direct benefit of renewable electricity. The model predicts that electricity importing (exporting) countries will choose policies which reduce (increase) electricity prices. A narrow pursuit of domestic objectives distorts transmission investment, and thereby market integration, below the efficient level. Distortions cannot be corrected by imposing national renewable targets alone. Instead, subsidies for transmission investment and a harmonization of and reduction in the number of policy instruments can improve welfare.

Download: Renewable electricity policy and market integration by Thomas Tangerås

Improperly designed subsidies to wind power raised balancing costs

by Johannes Mauritzen examines Danish wind power for the period 2010-2012 and reveals that wind power producers covered production deficits by increased participation at the short term market, Elbas, while production surpluses led to less market participation. A probable explanation was a subsidy scheme that weakened the incentive for owners of wind power plants to compensate production surpluses on the short-term market. Instead, the system operator had to intervene to balance power supply. The problem of surplus wind power production diminished when the subsidies were phased out during late 2012.

Download: Now or later? Trading wind power closer to real-time and how poorly designed subsidies lead to higher balancing costs by Johannes Mauritzen

Congestion management in electricity networks

Wholesale electricity markets use different market designs to handle congestion in the transmission network. This paper compares nodal, zonal and discriminatory pricing in general networks with transmission constraints and loop flows. The conclusion is that the three market designs result in the same efficient dispatch in large games with many producers and certain information. However, zonal pricing with counter-trading results in additional payments to producers in export-constrained nodes, which leads to inefficient investments in the long-run.

Download: Comparison of congestion management techniques: Nodal, zonal and discriminatory pricing by Pär Holmberg and Ewa Lazarczyk 

Why are wind power plants in good locations scrapped first?

The most common reason for scrapping a wind turbine in Denmark is to make room for a newer turbine. The decision to scrap a wind turbine is then highly dependent on an opportunity cost that comes from the interaction of scarce land resources, technological change and changes in subsidy policy. This research paper shows that turbines located in areas with better wind resources are at a higher risk of being scrapped. Policies put in place to encourage the scrapping of older, poorly placed turbines actually have a larger effect on well-placed turbines.

Download: Scrapping a wind turbine: Policy changes, scrapping incentives and why wind turbines in good locations get scrapped first by Johannes Mauritzen

The price- and quantity ladder might affect bidding behaviour in electricity auctions

In most wholesale electricity markets generators must submit step-function offers of supply to a uniform price auction, and the market is cleared at the price of the most expensive offer needed to meet realised demand. Such markets can most elegantly be modelled after the pure-strategy, Nash Equilibrium of continuous supply functions, in which each supplier has a unique profit maximising choice of supply function given the choices of other suppliers. Critics argue that the discreteness and discontinuity of the required steps can rule out pure-strategy equilibria and may result in price instability. This paper argues that if prices must be selected from a finite set the resulting step function converges to the continuous supply function as the number of steps increases, reconciling the apparently very disparate approaches to modelling electricity markets.

Download: Supply function equilibria: Step functions and continuous representations by Pär Holmberg, David Newbery and Daniel Ralph

The Swedish support system for renewable electricity is inefficient

Sweden has decided to increase electricity production from renewable energy sources such as wind, water and biofueled thermal power. Green certificates are the primary support system for renewable electricity: Generation companies receive one certificate for every MWh of approved renewable electricity they produce. The certificates are sold primarily to retailers who are legally bound to cover a share of final consumption by certified electricity. Certificate revenue adds to the income from selling the electricity itself, thereby stimulating the production of renewable electricity. This paper reexamines the Swedish support system and address problems associated with the certificates and the permit processes surrounding investments in renewable electricity.

Download: A reexamination of renewable electricity production in Sweden by Sven-Olof Fridolfsson and Thomas Tangerås

Discriminatory auctions probably increase volatility and production costs in the electricity market

Using the concept of market-distribution functions, we derive general optimality conditions for discriminatory divisible-good auctions, which are also applicable to Bertrand games and non-linear pricing. We introduce the concept of offer distribution function to analyze randomized offer curves, and characterize mixed-strategy Nash equilibria for pay-as-bid auctions where demand is uncertain and costs are common knowledge; a setting for which pure-strategy supply function equilibria typically do not exist. We generalize previous results on mixtures over horizontal offers as in Bertrand-Edgeworth games, but more importantly we characterize novel mixtures over partly increasing supply functions.

Download: Mixed strategies in discriminatory divisible-good auctions by Eddie Anderson, Pär Holmberg and Andy Philpott

The interaction between Danish wind power and Norwegian hydro power

It is well established that hydro power can act as a complement to large amounts of intermittent energy. In particular, hydro power can act as a "battery" where large amounts of wind power are installed. This new research paper uses simple distributed lag models with data from Denmark and Norway. Increased wind power in Denmark is found to cause increased marginal exports to Norway. This effect is larger during periods of net exports when it is difficult to displace local production. Increased wind power can also be shown to slightly reduce prices in southern Norway in the short run. Finally, estimates show that as much as 40 percent of wind power produced in Denmark is stored in Norwegian hydro power magazines.

Download: Dead battery? Wind power, the spot market, and hydro power interaction in the Nordic electricity market by Johannes Mauritzen

More wind power implies less intra-day price variability

Wind power has become an increasingly important source of electricity production around the world. Wind power is a volatile source of energy as it only delivers power when the wind blows. Hence, additional wind power will impact the average price as well as price volatility. This is one of the first empirical studies on the effects of wind power on the price variability of electricity and is based upon data from Denmark. Surprisingly, more wind leads to less intra-day price variability. This result probably is due to wind power cutting price spikes at peak hours.

Download: What happens when it's windy in Denmark? An empirical analysis of wind power on price variability in the Nordic electricity market by Johannes Mauritzen

Optimal transmission regulation of an integrated energy market

The capacity of the transmission network determines the extent of integration of a multi-national energy market. Cross-border externalities render coordination of network maintenance and investments across countries valuable. Is it then optimal for a single regulator to collect power? Should a common system operator manage the entire network? I show that optimal network structure depends on (i) how the common regulator would balance the interests of the different member states; (ii) how the gains from market integration vary across countries; (iii) network characteristics (substitutability versus complementarities); and (iv) the social cost of operator rent.

Download Optimal transmission regulation of an integrated energy market by Thomas Tangerås

Can forward trading improve electricity wholesale competition?

Forward sales is a credible commitment to aggressive spot market bidding, and it mitigates producers’ market power in electricity markets. Still it can be profitable for a producer to make such a commitment if it results in a soft response from competitors in the spot market (strategies are substitutes). The optimal contracting level of a risk-neutral producer is determined by the extent to which strategies are substitutes and the slope of the residual demand in the forward market. Conditions under which strategies are substitutes are identified for a two-stage game with supply function competition and capacity constrained producers.

Download Game-theoretical, strategic forward contracting in the electricity market by Pär Holmberg

How to reduce welfare losses in the electricity spot market?

The supply function equilibrium provides a game-theoretic model of strategic bidding in oligopolistic wholesale electricity auctions. This paper presents an intuitive account of current understanding and shows how welfare losses depend on the number of firms in the market and their asymmetry. Previous results and general recommendations for divisible-good/multi-unit auctions provides guidance on the design of the auction format, setting the reservation price, the rationing rule, and restrictions on the offer curves in wholesale electricity auctions.

Download The supply function equilibrium and its implications for wholesale electricity auctions by Pär Holmberg and David Newbery

Governance structure affects real exchange rates in oil-exporting countries

Institutional and political characteristics affect the extent to which the real exchange rates of oil-exporting countries co-move with the oil price. In a simple theoretical model, good governance insulates real exchange rates from price volatility by generating a smoother pattern of fiscal spending over the resource price cycle. Empirical tests on a panel of 33 oil-exporting countries provide evidence that countries with high bureaucratic quality, strong and impartial legal systems, democratic governing systems, and more equal income distributions have real exchange rates which co-move less with the oil price.

Download: Oil Prices and Real Exchange Rate Volatility in Oil-Exporting Economies: The Role of Governance by Johanna Rickne

How competitive is the Nordic electricity wholesale market?

In this paper we review the recent empirical research concerning market power on the Nordic wholesale market for electricity, Nord Pool. There is no evidence of blatant and systematic exploitation of system level market power on Nord Pool. However, generation companies seem from time to time to be able to take advantage of capacity constraints in transmission to wield regional market power. Market power can manifest itself in a number of ways that have so far escaped empirical scrutiny. The report discusses investment incentives, vertical integration and buyer power, as well as withholding of base-load (nuclear) capacity.

Download Market power in the Nordic electricity wholesale market: A survey of the empirical evidence by Sven-Olof Fridolfsson and Thomas Tangerås

Do pay-as-bid auctions lead to lower electricity prices?

The intention of the pay-as-bid auction, as used in the electricity market of Great Britain, is to lower prices. This paper characterizes supply function equilibria (SFE) in pay-as-bid auctions and compares them to SFE in uniform-price auctions. It is shown that offers shift upwards in the pay-as-bid auction, but still electricity consumers get a larger surplus than in the uniform-price auction. A potential problem is that pure-strategy SFE in the pay-as-bid auction might not exist.

Download Supply function equilibria of pay-as-bid auctions by Pär Holmberg

Unique supply function equilibrium with capacity constraints

In electricity auctions producers submit supply functions specifying the amount they are willing to produce at various prices. In Supply Function Equilibrium (SFE), every firm commits to the supply function that maximises expected profit given the supply functions of the competitors. A basic weakness of the SFE is the presence of multiple equilibria. This paper shows that there is unique equilibrium if capacity constraints in the market bind with a positive probability. The equilibrium is determined by the price cap and the market capacity.

Download Unique supply function equilibrium with capacity constraints by Pär Holmberg

Numerical calculation of an asymmetric supply function equilibrium with capacity constraints

This paper presents an algorithm for solving the equilibria of an electricity auction where producers submit supply functions. The paper includes an example based on the electricity market in England & Wales.

Download Numerical calculation of an asymmetric supply function equilibrium with capacity constraints by Pär Holmberg

Optimal regulation of cost and quality in electricity distribution networks

Electricity distribution networks are natural monopolies and thus unsuitable for deregulation. However, the regulator can simulate market conditions by rewarding networks according to their performance in relation to other networks operating under comparable conditions. This project analyses how one should optimally construct such yardstick competition schemes to balance efficiency, quality and profitability considerations.

Download Yardstick competition and quality by Thomas Tangerås

International cooperation

Visiting researchers

Collaborating with others is essential for IFN as a research institute. Our researchers co-author articles with colleagues from other institutes, and many also teach at various universities and colleges.

As part of our extensive program of guest researchers, leading international researchers visit the institute. The visitors present and pursue their research as well as interact and cooperate with researchers at IFN.

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