Tacit Collusion in Repeated Unit Commitment Auctions

Joseph E. Duggan Jr.∗ April 30, 2019

Extended Abstract

In this preliminary work, I have begun to explore tacit collusion in infinitely repeated unit commitment auctions. In particular, whether the centrally committed market design characteristic of wholesale electricity markets in the United States more or less easily faciliates collusion than the self-committed market designs common to Western Europe and Australia. This work will represent a step towards better understanding the interplay between wholesale electricity market designs and the sustainability of collusion, a question of both theoretical market design relevance as well as practical regulatory import. Under both market designs, firms compete in a uniform price auction mechanism that is run by a third-party market operator. However, these market designs differ in how the generating firms submit their offers and the manner in which commitment and dispatch decisions are made. Under the centrally-committed market design, generating firms submit complex offers that contain information regarding the non-convexities of their operating costs. For example, a bid may contain information about marginal cost as well as the fixed start-up cost of activating a generator. On the basis of these submitted bids, the market operator determines commitment (the binary decision of whether or not a generator is activated) and dispatch (how much a generating firm is called to produce) to serve demand at lowest cost on the basis of the submitted bids. Given that the market price of energy may not be enough to cover fixed operating costs, under the centrally-committed market design there exists a make-whole provision guaranteeing that generating firms that are called to produce will break even on the basis of their submitted offers. Importantly, there is no guarantee that firms are bidding their costs truthfully. Under the self-committed market design, generating firms submit a simple offer representing the lowest price at which it is willing to supply the entirety of its capacity. There are no make-whole provisions in the self-committed market design, so generating firms must internalize the non-convexities of their operating costs in their simple price offers. To my knowledge, this work will be the first attempt to directly compare the sustainability of

∗Department of Economics and Finance, University of Dayton, 300 College Park, Dayton, Ohio, 45469, United States of America: [email protected]

1 collusion across these two market designs in an infinitely repeated game setting. Preliminary work suggests that the self-committed market design may more easily facilitate tacit collusion in the infinitely repeated game setting. It has been shown that uniform price auctions may more readily facilitate collusion than discriminatory price auctions (Fabra (2003)). In a uniform price auction, the market price of energy is determined by the highest accepted (the marginal) bid. This implies that a collusive price can be maintained by firms with inframarginal bids submitting offers low enough that they could not be profitably undercut by the marginal firm. This is made possible by the fact that the low bids are payoff irrelevant given that the market price is determined solely by the marginal bid. This type of pricing scheme is not feasible in the discriminatory auction, where each firm with an accepted bid is paid its own unique offer. Sioshansi and Nicholson (2011) were the first to formally model the bidding and incentive properties of generating firms competing in centrally-committed versus self-committed wholesale electricity markets. In a symmetric duopoly setting, they derived Nash equilibrium bidding behavior and expected costs across the two market designs. In their duopoly setting, they also found that the two market designs are expected cost equivalent. However, Duggan and Sioshansi (2018) determined that this cost equivalence result fails to hold in the more general setting of an oligopoly with three or more firms. Indeed, self-committed markets are found to be potentially more costly in a general oligopoly setting. This forms a primary motivation for the preliminary work of this extended abstract. Both Sioshansi and Nicholson (2011) and Duggan and Sioshansi (2018) model the auction environments as single-shot games. Examining these market designs in an infinitely repeated context will help illuminate whether one design more easily facilitates collusive behavior. There is an extensive literature on unit commitment auctions and the relative merits and demerits of centrally-committed versus self-committed electricity markets. Padhy (2004) provides a comprehensive survey on the formulation and solution of unit commitment models. Hogan (1994) and Ruff (1994) advocate centrally-committed markets over self-committed markets on the basis that the more complex offers give the market operator more information for making efficient commitment and dispatch decisions. However, there is no guarantee that the generating firms bid truthfully. Elmaghraby and Oren (1999) discuss the merits of self-committed markets given the incentive issues of the centrally-committed design. While this remains a work in progress, an infinitely repeated auction model of centrally versus self committed wholesale electricity markets will be studied. Analyzing an infinitely repeated game framework and looking at one-shot deviation gains, I will examine if one design is superior to the other in terms of facilitating tacit collusion. By enriching the duopoly model of Sioshansi and Nicholson (2011) which was further generalized to an oligopoly setting by Duggan and Sioshansi (2018), I am hoping to determine whether a self-committed market design may more easily facilitate collusion than a centrally-committed market design. Preliminary analyses suggests that this is indeed the case. More concrete results will be obtained in time for the International Conference on Game Theory in July. This study will provide two main contributions. By studying how market designs for wholesale electricity may hinder or facilitate collusion, it will contribute to the literature on procurement auctions, applied game theory, and market design. This study will also have practical relevance for regulators and public policy analysts in that it will aid our understanding of how collusive outcomes may be sustained and how they may be deterred

2 in the context of repeated unit commitment auctions. Given the debates surrounding how market designs may need to be rethought in light of the introduction of renewable generation, this study may represent a step towards better informed electricity market design decisions.

Keywords: Electricity Markets, Market Design, Unit Commitment, Auctions, Repeated Games

JEL Classiﬁcation: C72, D43, D44, D47, L13, Q4

References

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