Market Architecture

1
Market Architecture

• Robert Wilson
• Stanford University

2
New Markets in Basic Industries

• Privatization / Liberalization
  (worldwide)Deregulation / Restructuring (in
  U.S.)
• Communications, Energy, Transport, Water
• Motives ? Efficiency ? InvestmentArguments ?
  Scale ? ? Contestability Markets get prices
  (incentives) right Light-handed regulation
  suffices
• Implementation requires Market Design

3
Elements of Market Design

• Inputs Scarce resources. Outputs Products,
  services.Instruments Tradable rights and
  contracts.Markets Physical forward and spot.
  Financial hedges.Prices Bids. Allocation rules.
  Settlement rules.
• Efficiency Gains in short-run. Investments
  long-run.
• Incentives
• Procedures invulnerable to gaming
• Rules Incentives ? Efficiency (2nd Best)
• Mitigate or control market power

4
Wholesale Electricity Markets

• Energy Long-forward. Day-ahead, Day-of.
  Real-time.
• Markets Bilateral. Exchange. Spot
  Real-time
• Transmission Day-ahead. Real-time.
• Managed by SO System
  Operator
• Markets Congestion pricing, or purchase
  counterflow
• Reserves Capacity Day-head. Energy
  Real-time.
• Markets Auctions by SO. Real-time control by
  SO.
• Hedges Energy (Futures, CFDs). Transmission.
• Markets Auctions by SO. Secondary markets.

5
Simplified Electricity Market
Transmission Capacity B?A
Supply Incs in A in B
Supply into A net of Demand in B
Congested Price in A
P(A)
Uncongested Energy Price
Demand into A net of Supply in A
P(B)
Supply Decs in B in A
Congested Price in B
Imports into Region A Exports from Region B
Transmission Uses A-Incs B-Decs
Transmission Charge P(A) ? P(B)
Spot Market Uses all Incs Decs
Note actual market has many zones or nodes
6
Design Issue 1Centralized v Decentralized(Compl
ete v Incentives)

• Centralized consolidated marketsSO optimizes
  everything energy, trans., reservesPrices
  shadow prices on constraints
• Prices are right if model good data accurate
• Decentralized separated marketsPX clears
  markets, SO conducts auctionsPrices clearing
  prices
• Prices are right if markets are complete
  perfectly competitive

7
Institutional Perspectives

• Centralized designs are based on
• Relational contracting. SO Traders
  agent.Organizational structure inherited from
  utilities.
• Objectives reliability, coordination, pricing.
• Incentives sanctions. Abuses are penalized.
• Decentralized designs are based on
• Voluntary participation, bidding,
  availability.Few markets based on simple market
  clearing.
• Objectives efficiency, competition, min-SO.
• Incentives market prices for deviations.

8
Theoretical Perspectives

• This debate is like 1930s Lange-Lerner.Basic
  fact is primal-dual equivalence of quantity and
  price mediated mechanisms.
• Can incomplete and imperfect markets match
  optimization?
• Requires good price discovery repeat mkts.
• Is decentralization necessary to promote
  competition and strengthen incentives?
• Centralized designs cannot provide sufficient
  incentives if pricing is constrained (Vickrey).

9
Examples of Incompleteness

• Simple contracts with retail customers
• So demand highly stochastic (and no storage!)
• Energy Forward markets clear each hour
  independently. No contingent contracts.
• Transmission Scarce resources arenot priced
  when large zones are used.
• Reserves Capacity is priced imperfectly on
  relevant quality dimension -- response
  time.These are a few among many.

10
Example of Gaming

• Centralized set price at each node.
• Nodal Price Energy Price Injection
  Chargefrom Demand Supply Trans. ?
  Capacity
• Decentralized 1st clear DA energy market,2nd
  adjust energy in zones, 3rd use incs/decs.
• Gaming bidder sells huge quantity day-ahead that
  the SO is forced to sell back at low-priced dec
  in the spot market. Enter at congested node!
• This is inevitable consequence of unpriced scarce
  resources (i.e., incomplete market).

11
Other Effects of Incompleteness

• Impaired Efficiency
• Intertemporal effects are ignored.Startup costs,
  ramping constraints,
• Flexible resources reserves are
  under-priced.Due to lack of contingent planning
  or contracts.
• Entrants attracted to wrong locations.Due to
  unpriced transmission constraints.
• Sequence of markets depends on rational
  expectations. Anticipate transmission charge.
• Impaired Competition
• Each incompleteness invites gaming.

12
Remedies for Incompleteness

• Sequence of markets
• Repeated trading of simple contracts(long-forward
  , day-ahead, hour-ahead, spot) approximates
  complete market.Transmission is similar if
  pricing is locational at nodes.
• Better price discovery
• Iterative auction approximates Walrasian
  modelbut requires good activity rules.Example
  use it or lose it options.
• Complex market-clearing procedures
• Requires consolidated markets run by SO ?

13
Summary

• Can centralization work well? complete
• Strengthen competition, or use incentive-compatibl
  e settlement rules (e.g., Vickrey).
• Can decentralization work well? incentives
• It works - systems are operating
  successfully.Most are seen as promoting
  competition.
• But to price efficiently and prevent gaming
  requires effectively complete markets.
• Can this be done without consolidated
  market?Working hypothesis is ultimately yes -
  after many improvements to control gaming.

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Design Issues 2, 3(Addressed in text of paper)

• Design details of each market
• Energy bilateral contracting, or an exchange.
• Transmission
• Implementing nodal pricing in decentralized
  market
• Markets for hedges, firm transmission rights
• Reserves design of two-dimensional auctions
  (available capacity, contingent energy supply).
• Mitigation of market power
• Divestiture. Contract cover. Supply auctions.

15
Comparisons with Other Industries

• Transport industries with similar issues but
  different solutions
• Gas pipelines
• Rail networks
• Telecommunication networks
• To what extent are solutions derived from
• Technical differences?
• Point-to-point transport
• Ownership and control?
• Each network privately owned and managed, no SO!