Efficiency Impact of Convergence Bidding on the California Electricity Market

The California Independent System Operator (CAISO) has implemented Convergence Bidding (CB) on February 1, 2011 under Federal Energy Regulatory Commission’s (FERC) September 21, 2006 Market Redesign and Technology Upgrade (MRTU) Order. CB is a financial mechanism that allows market participants, including electricity suppliers, consumers and virtual traders, to arbitrage price differences between the day-ahead (DA) market and the real-time (RT) market without physically consuming or producing energy. In this paper, we analyze market data in the CAISO electric power markets, and empirically test for market efficiency by assessing the performance of trading strategies from the perspective of virtual traders. By viewing DA-RT spreads as payoffs from a basket of correlated assets, we can formulate a chance constrained portfolio selection problem, where the chance constraint takes two different forms as a value-at-risk (VaR) constraint and a conditional value-at-risk (CVaR) constraint, to find the optimal trading strategy. A hidden Markov model (HMM) is further proposed to capture the presence of the time-varying forward premium. Our backtesting results cast doubt on the efficiency of the CAISO electric power markets, as the trading strategy generates consistent profits after the introduction of CB, even in the presence of transaction costs. Nevertheless, by comparing with the performance before the introduction of CB, we find that the profitability decreases significantly, which enables us to identify the efficiency gain brought about by CB. R. Li · S. S. Oren Department of Industrial Engineering and Operations Research, University of California Berkeley, 4141 Etcheverry Hall, Berkeley, CA 94720, USA E-mail: [email protected] R. Li E-mail: [email protected] A. J. Svoboda Pacific Gas and Electric Company, 77 Beale Street, San Francisco, CA 94105, USA E-mail: [email protected] September 1, 2014