Manipulation of Day-Ahead Electricity Prices Through Virtual Bidding

Enforcement actions of the Federal Energy Regulatory Commission (FERC) in regard to allegations of price manipulation in electricity markets have been the source of a great deal of controversy in recent years. In several of these cases, the agency has accused banks, energy trading firms and other participants in physical and financial electricity markets of taking uneconomic positions in the physical market to reap gains in related financial positions. Most pending investigations and proceedings have ended with settlement agreements, which typically contain no admission of wrongdoing and no analysis of the underlying claims. the Commission's approved settlements levied roughly $445 million in civil penalties and disgorgement against six companies. JP Morgan's $410 million penalty, the largest one handed down by the Commission so far, is well below the $488 million proposed for Barclays Bank and four of its former traders for allegedly manipulating electricity prices in California between 2006 and 2008. The tendency to resolve enforcement cases via settlement has raised concerns among market participants and analysts: settlement agreements provide little information about the details of the alleged violations, and thus offer limited insights about FERC's interpretation of its fraud-based anti-manipulation rule. Real-time physical markets are vulnerable to manipulation, and extensive monitoring and mitigation rules are in place to prevent such manipulation. Absent control over real-time markets, the special nature of electricity cash settlement rules makes day-ahead manipulation more difficult than with storable commodities. So-called virtual trades are day-ahead financial transactions that mimic physical bids and offers, but are settled at the real-time energy price. Financial Transmission Rights (FTRs) are financial instruments that entitle the holders to receive a share of the congestion rents created when the network is constrained in the day-ahead energy market, and provide a hedge against variations in nodal prices and associated congestion charges. In this article, our focus is on one particular type of market manipulation strategy considered by FERC: placing virtual bids that are unprofitable on a stand-alone basis, but are intended to move day-ahead electricity prices in a direction that enhances the value of related FTR positions. Ledgerwood and Pfeifenberger (2013) show how, given the positions of other market participants, an energy trader would have an incentive to submit an excessive number of uneconomic virtual demand bids at a node representing the sink of its FTR position. Because the FTR pays the holder, for each megawatt awarded, the difference between the day-ahead congestion …