Abstract:
This paper examines the impact of market organization on efficiency and social welfare in the electricity market. Wholesale electricity markets exhibit two basic forms of organization: the decentralized bilateral trading market and the centralized auction market. While the centralized market may improve efficiency through information aggregation, it may also reduce efficiency by exacerbating the incentive faced by market participants to exercise market power. Taking advantage of Texas’ transition from a decentralized to a centralized market, I show that the informational effect dominates the effect of market power. Using detailed data on generation quantity, I find high-cost generators were displaced by low-cost generators in production. In the nine months following the transition, the total generation cost was reduced by $30.7 million, relative to the counterfactual. Although the centralized market led to private cost saving, it also had an unintended effect on emissions. For moderate estimates of marginal damages, the increased external costs of emissions completely offset the productive efficiency gain.