Convergence bids and market manipulation in the California electricity market

Abstract

Abstract Financial instruments are designed to improve the efficiency of a physical market in theory. In practice, underlying physical relationships may prevent financial instruments from working as intended. This paper analyzes the relationship between two financial instruments in electricity markets: convergence bidding and congestion revenue rights. Convergence bids allow participants to trade virtual power, whereas congestion revenue rights capture the value of congestion on a transmission line. Both instruments were introduced to solve inefficiencies, however the interaction of these two instruments provides incentives for manipulation. In this work I test whether the financial instruments are being used as intended. The results show that electricity market participants are more likely to hold unprofitable convergence bids on a node where the convergence bid can benefit the value of the congestion revenue rights held at that node. This type of uneconomic convergence bid is consistent with manipulative behavior. I then perform a back of the envelope calculation that shows these potentially manipulative convergence bids create inefficiencies in the market.