Limits to arbitrage in electricity markets: A case study of MISO

Abstract We study the case of financial traders in the Midwest electricity market, where they are expected to arbitrage price differences that result in inefficiencies. Using exogenous variation in financial trading from the financial crisis and a period of high transaction costs, we show speculators had only a weak effect. Moreover, while arbitrage was restricted by transaction costs imposed by regulation, some financial players bet in exactly the opposite direction of the pricing gap, sustaining large losses while doing so. We show this is consistent with price manipulation intended to increase the value of a related instrument that bets on local price differences (FTRs).

[1]  Shmuel S. Oren,et al.  The inherent inefficiency of simultaneously feasible financial transmission rights auctions , 2010 .

[2]  Erkko M. Etula.  Broker-Dealer Risk Appetite and Commodity Returns , 2010 .

[3]  Leigh Tesfatsion,et al.  Derivation of Locational Marginal Prices for Restructured Wholesale Power Markets , 2009 .

[4]  Erin Mastrangelo,et al.  Financial Arbitrage and Efficient Dispatch in Wholesale Electricity Markets , 2015 .

[5]  James Bushnell,et al.  Diagnosing Market Power in California's Restructured Wholesale Electricity Market , 2000 .

[6]  Johannes Pfeifenberger,et al.  Using Virtual Bids to Manipulate the Value of Financial Transmission Rights , 2012 .

[7]  Christopher R. Knittel,et al.  Inefficiencies and Market Power in Financial Arbitrage: A Study of California's Electricity Markets , 2004 .

[8]  Measuring the Benefits of Greater Spatial Granularity in Short-Term Pricing in Wholesale Electricity Markets , 2011 .

[9]  Lutz Kilian,et al.  The Role of Inventories and Speculative Trading in the Global Market for Crude Oil , 2010 .

[10]  D. Hirshleifer.  Residual Risk, Trading Costs, and Commodity Futures Risk Premia , 1988 .

[11]  A. Shleifer,et al.  The Limits of Arbitrage , 1995 .

[12]  J. E. Payne,et al.  Short term forecasting of electricity prices for MISO hubs: Evidence from ARIMA-EGARCH models , 2008 .

[13]  L. Tesfatsion,et al.  Locational marginal pricing basics for restructured wholesale power markets , 2009, 2009 IEEE Power & Energy Society General Meeting.

[14]  Seabron Adamson,et al.  Efficiency of Financial Transmission Rights Markets in Centrally Coordinated Periodic Auctions , 2010 .

[15]  Luciana Juvenal,et al.  Speculation in the Oil Market: SPECULATION IN THE OIL MARKET , 2015 .

[16]  Hassan Tehranian,et al.  Liquidity Risk Management and Credit Supply in the Financial Crisis , 2010 .

[17]  Christopher R. Knittel,et al.  The Simple Economics of Commodity Price Speculation , 2013 .

[18]  A. Kirilenko,et al.  Convective Risk Flows in Commodity Futures Markets , 2012 .

[19]  A. Ott,et al.  Experience with PJM market operation, system design, and implementation , 2003 .

[20]  S. Borenstein,et al.  The Competitive Effects of Transmission Capacity in a Deregulated Electricity Industry , 1997 .

[21]  Catherine D. Wolfram,et al.  Measuring Duopoly Power in the British Electricity Spot Market , 1999 .

[22]  Celeste Saravia.  Speculative Trading and Market Performance: The Effect of Arbitrageurs on Efficiency and Market Power in the New York Electricity Market , 2003 .

[23]  Frank A. Wolak,et al.  Measuring Unilateral Market Power in Wholesale Electricity Markets: The California Market, 1998-2000 , 2003 .

[24]  Ignacia Mercadal,et al.  Dynamic Competition and Arbitrage in Electricity Markets: The Role of Financial Traders , 2018, American Economic Journal: Microeconomics.

[25]  Mar Reguant,et al.  Sequential Markets, Market Power and Arbitrage , 2014 .

[26]  H. Bessembinder,et al.  Equilibrium Pricing and Optimal Hedging in Electricity Forward Markets , 2002 .

[27]  L. Kilian,et al.  The Role of Speculation in Oil Markets: What Have We Learned So Far? , 2012 .

[28]  Steven L. Puller.  Pricing and Firm Conduct in California's Deregulated Electricity Market , 2007, The Review of Economics and Statistics.

[29]  S. Borenstein,et al.  An Empirical Analysis of the Potential for Market Power in California&Apos;S Electricity Industry , 1998 .

[30]  F. Longstaff,et al.  Electricity Forward Prices: A High-Frequency Empirical Analysis , 2002 .

[31]  Akshaya Jha,et al.  Testing for Market Eciency with Transactions Costs: An Application to Convergence Bidding in Wholesale Electricity Markets , 2013 .

[32]  Arbitrage and Its Physical Limits , 2017 .

[33]  J. Tirole,et al.  Transmission rights and market power on electric power networks , 1999 .

[34]  James E. Payne,et al.  Day-Ahead Premiums on the Midwest ISO , 2009 .

[35]  David G. Loomis,et al.  Forecasting hourly electricity prices using ARMAX–GARCH models: An application to MISO hubs , 2012 .