Market Organization and Market Efficiency in Electricity Markets

Electricity markets in the United States exhibit two different forms of organization: decentralized bilateral trading and centralized auction markets. Using detailed data on prices, quantities, and production costs, we examine how market outcomes changed when a large region in the Eastern US rapidly switched from a bilateral system of trade to a well-designed centralized auction market in 2004. Although economic theory yields ambiguous predictions, the empirical evidence indicates that shifting the venue of trade substantially improved overall market efficiency, and that these efficiency gains far exceeded implementation costs. Our analysis points to the merits of organized market institutions for electricity, a central issue in policy debates over market-oriented regulatory reforms. † Yale School of Management, 135 Prospect St., P.O. Box 208200, New Haven, CT 06520-8200, Yale School of Forestry and Environmental Studies, and NBER. Email: [email protected]. ‡ The Wharton School, University of Pennsylvania, Philadelphia PA 19104-6372, and NBER. Email: [email protected]. Acknowledgments. The authors gratefully acknowledge the University of California Energy Institute for facilitating access to proprietary industry transaction data for this project. Special thanks to Joe Bowring and the Market Monitoring Unit of the PJM Interconnection, LLC., for helpful discussions and information about market procedures, and to Frank Wolak for comments on an earlier draft. v7.19