Strategic bid response under automated market power mitigation in electricity markets

Abstract

In auction markets that are prone to market power abuse, preventive mitigation of bid prices can be applied through automated mitigation procedures (AMP). Despite the widespread application of AMP in US electricity markets, there exists scarce evidence on how firms strategically react to such price-cap-and-penalty regulation: when the price cap rarely leads to penalty mitigation, it is difficult to distinguish whether AMP are an effective deterrent or simply too lax. We investigate their impact on the bids of generation firms, using 2019 data from the New York and New England electricity markets (NYISO, ISO-NE). We employ a regression discontinuity design, which exploits the fact that the price cap with penalty is only activated when a structural index (e.g., congestion, pivotality) exceeds a certain cutoff. By estimating the Local Average Treatment Effect (LATE) of screening activation, we can causally identify successful deterrence of anti-competitive behavior. Around 30-40% of the analyzed bidders per market exhibit a significant strategic response - corresponding to a decrease in maximum bid prices of 4-10 $/MWh to avoid the penalty. However, there is significant heterogeneity between firms, and the regulatory impact on the overall market is not statistically detectable, suggesting lax mitigation thresholds. Using a merit-order simulation, we estimate the welfare impact of more stringent thresholds to lie between 350 and 980 thousand dollars of increased buyer surplus per mitigated hour, with the associated number of mitigated hours being below 33 hours/year. Our results motivate the empirical calibration of mitigation thresholds to improve the efficiency of AMP regulation.