Presentation by Bert Willems on 24 January 2020 @ the Florence School of Regulation: (1) When are bids excessive (2) Can excessive bids be fair (3) Are excessive bids harmful (4) Should we enforce

1. Discussion by Bert Willems
Market Abusive Practices
Bert Willems

2. • Economist’s view - Market design
• When are prices excessive?
• Are excessive prices fair?
• Are excessive prices harmful?
• Should we enforce?
• Reverse Chatham Rules for this talk: quote and attribute
Overview

3. What is non-excessive bidding ?
Firm acts as if it is a small, price-taking firm
with the same production technologies and same market design
• In a one-shot, non-discriminatory price auction, convex costs this implies that
bid = marginal production costs, but this is not true in general
• Bids should includes opportunity cost of not being active in subsequent/parallel markets
(balancing, intra-day, re-dispatch, reserves). Cf. water values for hydro
• In a pay-as-bid auction: bid corresponds to the expected market value of energy
• A competitive bid depends on marginal costs and on market fundamentals
• Competitive bid needs to include opportunity costs. EU market design relies on arbitrage!
(1) Excessive Prices  Excessive Bids/Withholding

4. • Innovation markets
• Medicines, technology standards, software platforms
• Ex-post large economies of scale, innovation is stochastic.
• Marginal cost pricing is insufficient to recoup innovation costs.
• Excessive prices (p>MC) are fair compensation for innovation costs
• Electricity markets
• No economies of scale in generation (size of market ≫ size power plant).
• No need to adjust MC for investment and capital costs.
• Note that firms have no guarantee to recoup investments costs in low demand years
• But
• MC is a step function
• Monopsony power of System Operator might depress prices
• Capacity remunerations mechanism shouldn’t matter:
(some mechanisms include a subsidy but that was the goal anyways)
(2) Are Excessive Prices Fair?
Non-excessive price
Excessive price

5. • Not all capacity withholding is strategic (failure of power plants) or directly hurts
consumers
• Balance responsible parties submit a balanced schedule: In expectation no net exposure to
real-time balancing prices  So limited incentives to withhold capacity (Allaz and Vila 93,
Brandts et al. 03, Bushnell et al. 08)
• Consumers with fixed retail price are insured.
• Theory of harm might be more complex than high prices (excessive price
combined with other abuses)
• Entry deterrence:
• Increase cost of flexibility (for wind producers, aggregators, small firms)
• Increase cost of hedging (less liquid commodity derivatives markets with market power).
• Influence future prices
• More empirical and theoretical research needed to understand linkage between
markets and theory of harm
(3) Theory of Harm – Incentives for firm

6. • US has extensive framework of monitoring, bid mitigation and ex-post evaluation of
technical availability of power plants: do we want to go there?
• Detection is harder in EU
• US: Firms bid production characteristics and markets are explicitly linked (= explicit arbitrage).
• EU: government second guesses firms’ strategies in complex multi-market environment & bilateral
contracting possible.
• Less harm in EU: retailers insure consumers against short-term price spikes and
reduces incentives for market power abuse in the spot market. Retailers bargain
upstream with producers, so retail competition helps price formation
EU should be more lenient towards excessive prices in balancing markets than US.
Heavy-handed mechanism from US might not be way forward.
Do not forget competition policy on retail markets, hedging & entry (Harm 10% mark-
up 8760hrs > 1000% mark-up 2hrs). Larger role for financial regulation on risk /
speculation. Competitive forward & retail markets  Positive spill-over to spot market
Whether to enforce remedies should also depend on efficiency of the remedy (e.g. bid
screen in Merit becomes an implicit bid cap. Rules on availability  soft regulation).
(4) Should we enforce and how?