Electricity auctions

This article examines auctions in the electricity industry. We find that th e laws of physics that rule power transmission networks defeat ex post prod uctive efficiency: the cheapest combination of generating plants is not alw ays selected, not even in the optimal auction. Furthermore, neither the pay -your-bid nor the uniform-price auction coincides in general with the optim al auction, nor do they yield productive efficiency. Our analysis also shed s light on behavior observed in existing power markets, and leads to policy recommendations. First, producers protected by transmission constraints mu st see their bids capped in the short run to curb their ability to extract large rents. Second, producers apparently hurt by the unavailability of tra nsmission capacity may benefit from it. Hence, contrary to common wisdom, p olicy makers cannot rely on them to finance or advocate transmission expans ion.