Simplified Electricity Market Models with Significant Intermittent Renewable Capacity: Evidence from Italy

Using hourly offer curves from the Italian day-ahead market and the real-time re-dispatch market for the period January 1, 2017 to December 31, 2018, we show how thermal generation unit owners are able to profit from differences between a simplified day-ahead market design that ignores system security constraints as well as generation unit operating constraints, and real-time system operation where these constraints must be respected. We find that thermal generation unit owners increase or decrease their day-ahead offer prices depending on the probability that their final output will be increased or decreased relative to their day-ahead schedules because of real-time operating constraints. First, we estimate generation unit-level models of the probability of each of these outcomes conditional on forecast demand and renewable production in Italy and neighboring countries. Our most conservative estimate of the impact of a change in the probability a unit owner will have its day-ahead schedule increased in the real-time re-dispatch market implies a day-ahead offer price increase of 5 EUR/MWh if this probability changes by 0.1. If the probability of a day-ahead schedule decrease rises by 0.1 the unit owner's offer price is predicted to be 6 EUR/MWh less. Over our sample period, we find that the economic re-dispatch cost averaged approximately 15% of the total cost of energy consumption valued at the day-ahead price.