Spatial Arbitrage to Reduce "Seams" across Electricity System Control Areas: An Experimental Analysis

Most markets are restricted in their spatial size by transportation costs, physical barriers, institutional impediments and differing exchange conventions. Yet, if price differences across those boundaries substantially exceed the cost of surmounting the barriers, tremendous pressure arises to facilitate exchange. So too where electricity markets are defined by operating control areas for reliability purposes, substantial price differences across tie-lines offer incentives for trade and profit. An arbitrage process is developed and tested experimentally that permits buyers and sellers to exchange power across the border of two separately optimized control areas, and the impact on price differences and the ability to exercise market power are explored. While economic efficiency is enhanced and the combined areas are shown to be more competitive than without exchange; nevertheless, the experimental results fall short of the theoretical economic ideal, participant learning is slow, and perverse price patterns (flow from high to low cost control areas) remain in many periods.