Auctions in the Electricity Market
Two Types of Auctions
In class, we talked about auctions in which buyers make competing bids to buy an item from a seller. The one who makes the highest bid gets the item, and depending on the type of auction, the winning bidder pays the value of his/her bid (for first-price auctions) or the value of the second-highest bid (for second-price auctions).
In the electricity market, there are two different auctions that are used: the uniform clearing price auction and the pay-as-bid auction. The situation is, in a way, reversed: there is one buyer, the operator of a section of the electricity grid, and many sellers, the electricity generators. The sellers compete with each other, submitting bids to sell electricity to the operator. The operator, of course, prefers the bids with lower value.
Unlike in the auctions discussed in class, more than one of the competing parties can win. In the electricity market auctions, the operator buys electricity from multiple generators, starting from the lowest bids and going upwards, buying from as many generators as is necessary to meet the demand.
The pricing of the electricity is different for the two types of auctions. In the uniform clearing price auction, the operator pays all the auction winners at the value of the highest bid accepted; this price is known as the clearing price. This means that the generators with the lowest bids get to make some money; the auction winner who bid the clearing price, on the other hand, gets a payoff of zero, assuming that it bid as much as it actually cost to produce the electricity.
In contrast, in the pay-as-bid auction, the operator pays each of the winning bidders at the price it bid. Such an auction design causes all the sellers in the auction to try to maximize their payoffs by guessing the clearing price and bidding close to the clearing price; this means all the bidders would bid higher than they would bid in the uniform clearing price auction.
Revenue Equivalence
The textbook for this class describes the revenue equivalence principle: across many types of auctions, a seller’s revenue is the same. In particular, the revenue is the same between first-price and second-price auctions: in a first-price auction, all buyers shade their bids down, but the seller pays the value of the highest bid instead of the second-highest; those two differences cancel out, so the revenue is the same.
However, this principle does not seem to hold for uniform clearing price auctions and pay-as-bid auctions. One might expect that the thing that causes prices to be lower (paying at the value of bids instead of at the clearing price) and the thing that causes prices to be higher (all the bidders submitting higher bids) would cancel out, but they do not. In a pay-as-bid auction, the buyer generally has to pay a higher price for electricity. This may be because the bidders do not use equilibrium bidding strategies. Also, they do not actually know how much it costs their competitors to produce electricity or how much their competitors plan to bid. So the revenue equivalence principle does not hold for all auctions.
http://www.epsa.org/industry/primer/?fa=prices
http://www.nyiso.com/public/webdocs/media_room/current_issues/uniformpricing_v_payasbid_tierneyschatzkimukerji_2008.pdf