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Inefficiencies and Market Power in Financial Arbitrage: A Study of California?s Electricity Markets

Author

Listed:
  • Christopher Knittel
  • Catherine Wolfram
  • James Bushnell
  • Severin Borenstein

    (Department of Economics, University of California Davis)

Abstract

As with other commodities, electricity is often traded on both forward and spotmarkets. This was initially true in the restructured California electricity industryfrom 1998 to 2000. Though the power traded in the forward and spot marketswas for delivery at the same times and locations, prices often differed in significantand predictable ways. We consider several explanations for this apparent inefficiency,concluding that uncertainty about regulatory penalties for trading in the spot marketcaused most firms to avoid trading on inter-market price differences. The few firmsthat did carry out these trades did not find it profit-maximizing to eliminate theprice differences. Skyrocketing prices in the summer of 2000, however, changed themajor buyers? (utilities?) incentives and increased the price differentials between themarkets.

Suggested Citation

  • Christopher Knittel & Catherine Wolfram & James Bushnell & Severin Borenstein, 2006. "Inefficiencies and Market Power in Financial Arbitrage: A Study of California?s Electricity Markets," Working Papers 105, University of California, Davis, Department of Economics.
    • Handle: RePEc:cda:wpaper:105
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    References listed on IDEAS

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