The California Electricity Crisis: An Experimental Investigation of the Effects of Changing the Market Rules

Motivated by the extremely high prices for wholesale electricity in California from May, 2000 to June, 2001, this paper presents the results from four economics experiments using both industry professionals and students who compete to sell electricity in a simulated market. The market structure in the first three experiments parallels the design of the California market over time: a uniform price last accepted offer auction, a soft-cap auction, and a soft-cap auction with priceresponsive demand. The fourth experiment is a uniform price auction with price-responsive demand. Our design includes salient features of the California market: generation costs that vary to simulate high prices of natural gas, a high ratio of demand to available capacity, and a hard price cap. Participants were able to manipulate the uniform price auction and attain prices near the price cap. These high prices were sustained in the next two experiments using a soft-cap auction, even though load was price responsive. Prices were noticeably lower in the uniform price auction with price-responsive demand. Since this paper analyzes the effects of changing the market rules in California, our objectives are quite different from the numerous studies which have evaluated the importance of market power as the cause of the “California crisis.”