Rational Buyer Meets Rational Seller: Reserves Market Equilibria under Alternative Auction Designs

We examine efficiency properties and incentive compatibility of alternative auction formats that an electricity network system operator may use for the procurement of ancillary services required for real-time operations. We model the procurement auction as a hierarchical multiproduct auction and study several designs such as a uniform price auction minimizing social cost, a uniform price auction minimizing the system operator's cost and a pay as bid auction. We take into account that rational bidders will respond to any market design so as to maximize their expected benefit from participating in that market. Under the assumptions of our model, we show that the uniform price auction minimizing social cost is the only one that guarantees productive efficiency. We also find that expected revenue (payment in our case) equivalence between pay as bid and uniform price auction does not extend to the hierarchical products case and the rankings of these auction is ambiguous and depends on the data. For the case where only higher capability resource are constrained this will result in random price spikes decreasing in frequency with the price cap (this is the amount paid to capacity in demand states with shortages). When lower type resources are capacity constrained as well, price spikes will be seen for both type of resources. Artificial shortages result in reduced reliability in real-time operations.