Bid Cost Minimization vs. Payment Cost Minimization: A Game Theoretic Study of Electricity Markets

Abstract

In deregulated electricity markets, auction mechanisms are used to select supply bids for energy and ancillary services. Currently, most independent system operators in the US use a "bid cost minimization" auction mechanism that minimizes total supply bid costs to select bids, and afterwards settle the market based on market-clearing prices. Consequently, the consumer payments could be significantly higher than the minimized bid cost from the auction. This gives rise to "payment cost minimization," an alternative auction mechanism that directly minimizes consumer payments. A review of literature shows that with the same set of supply bids, payment cost minimization leads to reduced consumer payments as compared to bid cost minimization. Since power suppliers may bid differently under different auction mechanisms, investigation of market behaviors is necessary for the comprehensive assessment of auction mechanisms. In this paper, strategic behaviors of suppliers are studied within the game theoretic framework for the two auction mechanisms. Simple two-supplier Nash games are first analyzed to provide insights. General matrix Nash games are then solved by using the approximate Nash concept and with our auction algorithms developed earlier as the core. Testing results demonstrate the cost savings for consumers under payment cost minimization as compared to bid cost minimization.