Simplified short-term electricity market designs: Evidence from Europe

Abstract

Electrical power is transmitted through a network, and the flows on this network are governed by the laws of physics. In market designs that do not accurately account for these realities, secondary mechanisms need to be deployed on top of a hypothetical dispatch originating from an “unconstrained” (or inaccurately constrained) market mechanism. This sequential approach can create operational risks, lead to inefficiencies, and distort the incentives of market participants in both the short and long run. I review these incentives by focusing on the Italian and Great Britain markets. Both systems employ market designs that, in line with the prevalent European design, are largely agnostic to the flow of power and other system constraints. The consequences of these market design choices are increasingly significant as the systems move toward decarbonization.