Trading Inefficiencies in California's Electricity Markets

Severin Borenstein, James Bushnell, Christopher R. Knittel, Catherine Wolfram

NBER Working Paper No. 8620
Issued in December 2001
NBER Program(s):The Industrial Organization Program, The Environment and Energy Program

We study price convergence between the two major markets for wholesale electricity in California from their deregulation in April 1998 through November 2000, nearly the end of trading in one market. We would expect profit-maximizing traders to have eliminated persistent price differences between the markets. Institutional impediments and traders' incomplete understanding of the markets, however, could have delayed or prevented price convergence. We find that the two benchmark electricity prices in California -- the Power Exchange's day-ahead price and the Independent System Operator's real-time price -- differed substantially after the markets opened but then appeared to be converging by the beginning of 2000. Starting in May 2000, however, price levels and price differences increased dramatically. We consider several explanations for the significant price differences and conclude that rapidly changing market rules and market fundamentals, including one buyer's attempt to exercise a form of monopsony power, made it difficult for traders to take advantage of opportunities that ex post appear to have been profitable.

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Document Object Identifier (DOI): 10.3386/w8620

Published: Borenstein, Severin, James Bushnell, Chris Knittel, and Catherine Wolfram. “Inefficiencies and Market Power in Financial Arbitrage: A Study of California's Electricity Markets." Journal of Industrial Economics 56, 2 (June 2008).

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