Market-based redispatch in zonal electricity markets inc-dec gaming as a consequence of inconsistent power market design (not market power)

In zonal electricity markets, such as Europe's, system operators relieve congested power lines within bidding zones using out-of-market measures. One such measure is "redispatching" power plants, i.e. increasing the output of one power station while decreasing the output of another. Traditionally, generators have often been legally obliged to participate in redispatch and were subsequently compensated by the system operator for costs in-curred. In recent years, with increasing pressure on power grids, numerous proposals have been made, including one by the European Commission, to organize redispatch through voluntary markets. In this paper, we introduce a simple graphical model of a zonal spot market with a locational, voluntary redispatch market to show that such a market-based solution should not be used in this setting. We solve the model explicitly by determining optimal bidding strategies and Nash equilibrium prices. We show that market parties anticipate the redispatch market and bid strategically in the spot market – the so-called increase-decrease game. As a result, grid congestion is aggravat-ed, producers extract windfall profits, financial markets are distorted, and perverse investment incentives emerge. Despite claims to the contrary, we show that such gaming is possible absent market power, i.e. if all generators ultimately bid marginal cost. At the root of the problem is inconsistent power market design: combining a regional with a locational market yields undue arbitrage opportunities that rational firms exploit. We conclude that such inconsistent market design should be avoided.