Working paper co-authored by Lion Hirth models threat of grid congestion and windfall profits.
A new working paper co-authored by Lion Hirth, Hertie School Assistant Professor of Governance of Digitalisation and Energy Policy shows that a European Commission proposal aimed at relieving overloaded power lines could encourage market participants to game the system.
The paper, co-authored by and Ingmar Schlecht of the University of Basel’s Center for Economic Science, demonstrates the downside of so-called redispatch markets to deal with power grid bottlenecks, a growing problem in Europe. The authors say they hope their findings will help “inform the European energy debate at a crucial crossroads.”
If European grid operators foresee that power line limits will be violated, they order one plant to increase production while asking another to reduce output. This is called "redispatch". In Germany and other countries, this takes place outside the marketplace through administrative measures that obligate power generators to participate. In recent years, numerous proposals have been made to organise redispatch through voluntary markets, and the European Commission has proposed making this obligatory.
Using a model of a zonal wholesale market with a nodal redispatch market, Hirth and Schlecht show how market participants would be incentivised to pursue strategic bidding strategies, engaging in a so-called increase-decrease game. This would actually aggravate grid congestion and create windfall profits for plant operators, they show.
Since the working paper was published, Hirth and Schlecht have added historical details about markets that previously suffered from increase-decrease gaming. This usually led to changes in market design or regulatory intervention, they say.
California, for example, introduced a zonal market with two bidding zones after liberalisation in 1996-98. Network congestion within the zones was managed with market-based redispatch (although that term was not used). Market parties, including Enron, engaged in increase-decrease gaming. As early as 1999, regulators concluded that this approach was flawed and needed overhauling. Gaming contributed to the 2000-01 energy crisis, when California suffered blackouts. As a consequence, California introduced nodal pricing in 2009.
Another such case occurred at the Scottish-English border, a line that was increasingly constrained after wind power expansion in Scotland. In 2012, the British regulator introduced the Transmission Constraint Licence Condition to prevent further gaming, penalising bids that resulted in “excessive benefits.” Today, this prevents generators from factoring in locational rents, a measure basically equivalent to cost-based redispatch.
Read the abstract and download the paper here.