Fighting the Darkness:
Illuminating Vulnerabilites in California's Electricity Pricing Policy
M. North*, C. Macal, V. Koritarov, T. Veselka, G. Boyd
north@anl.gov; http://www.cas.anl.gov


    Electricity pricing policies define how electric power producers are paid for their inputs to the power grid.  A variety of pricing policies is currently being used in electricity markets.  Determining an effective pricing policy is a complex endeavor that has important ramifications for market stability.  This stability can be threatened by strategic behavior such as that seen in California.  Understanding the vulnerabilities of electricity pricing policies before they are applied to the real world is critical.  Methods that can be used to test pricing policies before they are applied to real electric power markets are needed.
     The complex interactions and interdependencies between electric market participants are similar to those studied in the theory of repeated games and evolutionary game theory.  Unfortunately, the adaptive strategies employed by many electricity market participants are often too complex to be conveniently modeled using standard game theoretic techniques.  This suggests the use of a related approach, the development of agent-based models (ABM).  This approach was used to create the Electricity Market Complex Adaptive Systems Model (EMCAS).  The EMCAS ABM is designed to test some of the effects of electricity pricing policies before they are applied to real electric power markets.
     EMCAS is a Recursive Porous Agent Simulation Toolkit (RePast) ABM with agents that represent generation companies, demand aggregation companies, transmission companies, consumers, system operators, and government regulators.  These agents use a variety of computer learning techniques to improve their individual competitiveness as the market within which they are embedded evolves.
    To explore the EMCAS ABM's potential to test electricity pricing policies, two electricity pricing policies were compared.  A pricing policy requiring all transactions to use a spot market with locational marginal pricing (LMP) was compared to a pure spot market system with Pay-as-Bid pricing.  LMP below and Pay-as-Bid above a specified price cap was the electricity pricing policy in effect during the California Energy Crisis and still is today.  LMP is one of the most common electricity pricing policies. LMP is commonly used since it is widely believed that LMP pricing policies send appropriate price signals to consumers while also providing sufficient revenues for producers to maintain current production and invest in new production facilities.
     The EMCAS study results illuminate some of LMP's vulnerabilities to manipulation.  For example, under conditions of tight capacity, EMCAS model emergent behavior shows that LMP is highly vulnerable to "hockey stick" bidding strategies.  This emergent strategy employs low prices for the majority of each generation unit's capacity followed by extremely high prices for the last few Megawatt hours (MWh).  This approach can be extremely effective since it requires little risk but offers much to gain.  There is little risk since the vast majority of their low priced generation bids are likely to be accepted.  There is high potential gain since the LMP policy might assign the last few MWh's high prices to all purchased generation during times when demand nears supply.  The EMCAS study shows that Pay-as-Bid pricing may be much less vulnerable to such manipulation but may send excessively low price signals to producers.  This may tend to reduce producer's incentives to maintain current production capacity and invest in new production facilities, potentially leading to undesirable market cycles.
    By illuminating some of the vulnerabilities of California's electricity pricing policy, the EMCAS study demonstrates that ABMs can be used to test such policies, before they are applied to the real world.

This work is sponsored by the U.S. Department of Energy under contract number W-31-109-ENG-38.